Bank faces inflation headache as growth slows

By Matt Falloon

LONDON (Reuters) - New Bank of England economic forecasts on Wednesday will probably have a hawkish tinge despite a slowing economy, and may signal whether interest rate cuts risk drying up following some diabolical inflation data.

The Bank's crystal ball has warned policymakers for some time that they face a treacherous balancing act as inflation spirals upwards and growth cools.

Price pressures throughout the pipeline are at, or close to record levels and economic data is going from bad to worse, particularly in the housing market. The year that Bank Governor Meryvn King has called the toughest for a decade has just become a lot tougher.

Markets are jumpy and economists are finding it hard to predict when, or even if, interest rates will fall this year.

Last week, two banks switched forecasts against the tide to forecast a rate cut at the Monetary Policy Committee's May policy meeting -- which never came. This week those banks are suggesting a spike in inflation to 3 percent, shown in data on Tuesday, probably rules out a reduction even next month.

Now is the time for clarity and investors hope the Bank's Inflation Report on Wednesday will give it.

"The Bank is well and truly trapped," said Alan Clarke, an economist at BNP Paribas. "The weakest ever RICS house price reading on the same day as this diabolical news on inflation means choosing the lesser of two evils.

"We will learn more tomorrow, but if MPC cuts do dry up, the UK economy will be facing a severe risk of recession."