Leading article: The full extent of the crisis is only just emerging

Yesterday's figures for manufacturing inflation, showing a 10 per cent rise on the year, together with Sunday's rescue package for the stricken Fannie Mae and Freddie Mac mortgage concerns, can only make the policy dilemmas facing the Government ever more excruciating. The trouble is that the two developments face in diametrically opposite directions.

The factory gate prices announced yesterday only confirm what every shopper and motorist already knows. Prices are rising and the pace is accelerating. The primary causes are clear. They lie in the dramatic escalation in the price of oil and commodities. Those are largely beyond the Government's control. But their effect within the domestic economy are none the less serious for that, not least the threat of wage inflation from workers demanding compensatory increases.

The reference by Unison's general secretary, Dave Prentis, to a "winter of discontent" if the union's push for proper increases is ignored may be self-serving. But it creates a direct challenge that the Government cannot duck. In the public sector at least, it has to show toughness for fear of letting loose a tidal wave of competing claims. In the private sector, the Government can but hope that employers will resist high claims for fear that the consumer will walk away from the product or buy less of it. That may be unfair on the poorer paid. It is unfair. But it is the reality of the inflationary crisis now developing.

Equally painful is the option facing the Bank of England on interest rates. The rate of inflation, at more than 3 per cent even on the Government's much-altered statistical bases, is way above the 2 to 2.5 per cent which the Bank is supposed to aim for. By the end of the year, according to the Governor, Mervyn King, it may well be up to 4 per cent. Under any normal circumstances the Bank should be raising interest rates to squeeze inflation out of the system. The European Central Bank has already raised its rates once. Yet it is difficult to know how, under the present circumstances, this will help control a surge in prices that comes largely from the outside, other than by raising the value of sterling and making it more difficult for the one area of some resilience in the economy – exports. Worse, higher rates could make much worse the falls in house prices and consumption that the country is already witnessing.

That is where the US woes come in. There is no direct relationship between the Fannie Mae and Freddie Mac situation and that of British financial institutions, still less is there any direct comparison in the numbers involved. But the extraordinary and unprecedented measures announced by the US Treasury are a sure indication that the credit squeeze is very far from over. Even if the measures succeed in restoring banking confidence, the simple fact is that banks are now only willing to lend on the most secure of deals and then at high rates. And that in turn must further depress the housing market here. To raise the Bank rate now could make a bad situation very much worse.

So far the Bank and the Treasury have simply put off the decisions, partly because they don't know what to do and partly because they have been hoping that both the commodity price surge and the credit crunch will begin to lose momentum. In the short run they have the advantage that, as the bankers and politicians go off on holiday, the markets may be more restrained. But, come autumn, the pressures on consumption, employment and growth on the one side and the autumn wage round on the other will make prevarification damaging if not actually impossible. Even without strikes, this could indeed be the winter of discontent.