Business

Economy tracker: Inflation

  • 17 February 2015
  • From the section Business

Latest news:

Cheaper fuel and lower energy prices brought the rate of UK inflation to a record-equalling low in January, official figures show.

Inflation as measured by the Consumer Prices Index dropped to 0.3% last month, from 0.5% in December according to the Office for National Statistics.

The rate of Retail Prices Index (RPI) inflation, which is calculated differently, also continued a downward trend, falling to 1.1%, down from 1.6%.

The Bank of England said last week that inflation may temporarily turn negative in the spring.

Understanding inflation:

  • Inflation is a rise in the price of goods and services we buy
  • The annual rate of inflation shows how much higher or lower prices are compared with the same month a year earlier. It indicates changes to our cost of living
  • So if the inflation rate is 3% in January, for example, prices are 3% higher than they were 12 months earlier. Or, to look at it another way, we need to spend 3% more to buy the same things
  • We compare this to the annual change recorded in the previous month to get an idea of whether price rises are getting bigger or smaller
  • If the annual rate has risen from 3% to 4% from one month to the next, prices are rising at a faster rate
  • If the rate has fallen - say from 3% to 2% - prices of the things we buy are still higher, but have not increased by as much
  • If the percentage rate is negative - for example, -1% - then prices are 1% cheaper than a year ago
  • The figures are compiled by the Office for National Statistics. The inflation rate is calculated every month by looking at the changes in prices of 700 goods and services in 150 different areas across the UK.
  • This is known as the basket of goods and is regularly updated to reflect changes in the things we buy. Hence the recent inclusion of tablet computers and Twilight books and the exclusion of casserole dishes and photo printing services.
  • There are two main measures: the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). These are, in effect, two baskets comprising different goods and services, and different methods are used to calculate them. There are many differences, but the biggest is that RPI includes housing costs such as mortgage interest payments and council tax, whereas CPI does not

Background:

There have been dramatic changes in the rate of inflation in recent years.

In 2008, as the global financial crisis was taking hold, prices were rising at an annual rate of about 5%.

But less than a year later, prices were rising by about 1% on the CPI measure, but were actually falling by about 1.5% on the RPI measure.

By late 2011, prices were rising again with CPI at 5.2%, matching the record high set in September 2008. RPI rose to 5.6%, the highest annual rate since June 1991.

Since then both measures have fallen back again, with CPI now below the Bank of England's 2% target rate for the first time since November 2009.

So what was behind those big swings?

In the middle of 2008, record high oil prices were feeding through to higher prices of goods and increased energy bills and a fall in the value of sterling also forced up the cost of imported goods.

But by early 2009, the price of crude oil had slumped, losing two-thirds of its value in just six months, and the global recession had taken hold. In the UK, VAT was also cut from 17.5% to 15%, in an effort to stimulate spending. All of this contributed to the inflation rate falling.

Then VAT went back up to 17.5% at the beginning of 2010, and was increased further to 20% the following year. Big rises in gas and electricity bills, along with transport costs and food prices, pushed prices up further.

Since then, the rate of inflation has subsided as the impact of VAT rises and higher energy costs have fallen away.

What does falling inflation mean for households?

Economists broadly expect the UK to benefit from below-target inflation for some time.

That is seen as good news for households, where prices have risen faster than average incomes since the financial crisis.