Deflation looms as prices fall
The cost of living has fallen for another month, with inflation at 4.1% in November down from 4.5% in October.
The Consumer Prices Index (CPI) – the official measure of inflation – peaked in September at 5.2%. Cheaper crude oil and commodity prices have helped it fall back down towards the government's 2% target, with cheaper transport having a particularly large impact during November.
The average price of petrol fell by 9.3p per litre between October and November this year, to stand at 95.2p, compared with a rise of 3.5p last year. Diesel prices fell by 7.5p per litre this year compared with a rise of 5p last year.
There was also a fall in the price of second-hand cars compared with a rise a year ago.
However, economists had been expecting CPI to slow to 3.9% in November as a result of the 2.5% VAT cut.
The Office for National Statistics says inflation would have fallen further if it hadn’t been for price rises in the food and non-alcoholic beverages sectors. The cost of recreation and culture is also up over the past year.
Meanwhile, the Retail Prices Index (RPI) – which includes mortgage payments – slowed to 3% in November, down from 4.2% in October.
Jonathan Loynes, chief European economist at Capital Economics, says the fall in CPI means the UK is still on track to enter a period of deflation (the first for more than half a century) next year.
He adds: "Admittedly, the fall in the headline inflation rate from October’s 4.5% to 4.1% was rather smaller than expected. But [the rise in food costs and cheaper petrol] won’t prevent inflation falling much further over the coming months.
"We still expect CPI inflation to turn negative next summer, with RPI inflation dropping even further thanks to the extra downward pressure from house prices and mortgage payments."
Arek Ohanissian, economist at the Centre for Economic Business Research, agrees that the fall reinforces concerns that falling inflation will lead to a deflationary spiral.
"It remains to be seen if consumers will eventually expect deflation and correspondingly delay purchases in hopes of lower prices," he adds. "In the meantime, the falling inflation rate allows the Bank of England greater scope to lower the base rate to record lows."
Ohanissian warns that one consequence of significant cuts will be further devaluation of sterling.
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
This is the opposite of inflation and refers to a decrease in the price of goods, services and raw materials. Economically, deflation is bad news: the only major period of deflation happened in the 1920s and 1930s in the Great Depression. Not to be confused with disinflation, which is a slowing down in the rate of price increases. When governments raise interest rates to reduce inflation this is often (wrongly) described as deflationary but is really an attempt to introduce an element of disinflation.
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.