Permalinks in 2.5.1 break blog on outside page

WordPress is installed in a /blog folder. I want to include some blog posts in the index.php homepage. I’ve done that many times before without problems with previous versions of WordPress.

With 2.5.1 it works fine if I use default links, but as soon as I turn on fancy Permalinks I get ‘Sorry, no posts matched your criteria’ on my homepage.

I know there are many other forum posts about this and I’ve seen the Permalinks trouble shooting section, but I see no clear answers anywhere.

Is this a bug? If I can’t find an answer soon I may have to revert to an earlier version of WP. ??