Cost of living turns negative
The cost of living is set to fall to levels not seen since 1949 with one measure of inflation creeping into negative territory in March.
Official figures show annual inflation, as measured by the Retail Prices Index (RPI), went negative in March for the first time since 1960. It is now -0.4%, down from 0% in February.
The Consumer Prices Index (CPI) – the official measure of inflation that, unlike the RPI, does not include mortgage interest payments – fell to 2.9% in March, down from 3.2% in February and 3% in January.
The figures are largely in line with inflationary expectations, with the recession bringing the cost of living down. However, there are concerns the CPI is falling at a slower pace than anticipated.
Jonathan Loynes, chief European economist at Capital Economics, says that although CPI decreased last month, on the back of lower food and energy costs, the VAT cut last December has slowed its fall.
But he adds: “There are good reasons not to get too worried. For a start, energy prices should fall a fair bit further over the coming months. There are also some signs that food prices might have started to drop. And second, we suspect that the weakness of retail spending and activity in general will bear down strongly on core inflation in time.”
With these factors likely to keep inflation moving on a downward path, the threat of a longer period of deflation still looms.
“UK inflation is still set to drop a lot further and the threat of a broader bout of deflation has not evaporated,” warns Loynes.
The Bank of England’s base rate cuts have brought the RPI into negative territory, with mortgage interest payments down by 42.2% year-on-year.
Charles Davis, economist at the Centre for Economic Business Research, explains: “This – and particularly food and fuel costs – drove inflation on the PRI into negative territory. Inflation on this wider measure is likely to reach its lowest level since monthly data began in 1949 in the coming months.”
Davis believes the CPI will also turn negative later this year.
Given that RPI is used as a benchmark by many trade unions and organisations to gauge wage increases, experts forecast many employees could endure pay freezes - and even pay cuts - this year.
Pensioners are also likely to be affected by deflation, if it continues for the rest of the year, as the government uses September's RPI as a measure for annual rises in the state pension and other benefits.
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).
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).
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the 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.
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.