Sharp fall in cost of living
The official measure of the cost of living fell sharply in April, mainly as a result of cheaper energy bills and food prices.
The Consumer Prices Index (CPI) fell to 2.3% in April, down from 2.9% the previous month. CPI, which the Bank of England uses as its official measure of inflation to determine base rate movements, peaked last September at 5.2% but has been falling since then back towards its 2% target.
Meanwhile, the Retail Prices Index (RPI) – which unlike CPI includes housing costs such as mortgage interest payments – also experienced a dramatic fall during April; it turned negative last in March, but has now fallen further to -1.2%.
This is the lowest figure since records began in 1948. The Office for National Statistics, which compiles the inflation figures, says cheaper mortgage rates, combined with house price falls, and lower council tax rates compared with last year, contributed to the sharp fall. Home contents insurance premiums have also fallen in price.
The falls seen across both measures during April suggest that the UK is still heading towards a period of deflation, where prices fall rather than rise. If this happens, then the Bank of England is likely to maintain the base rate at its current level of just 0.5% for some time.
The central bank increases the base rate when inflation rises, in order to calm consumer demand and make borrowing more expensive.
Jonathan Loynes, chief European economist at Capital Economics, says: “April’s figures confirm that price pressures in the UK economy are still fading fast.”
He forecasts that the economic downturn means CPI could also turn negative in the months ahead: “Overall, a reminder that excessively low inflation, or deflation, is still a bigger risk over the next few years than a rapid rise in inflation.”
However, some economists do not expect CPI to turn negative - and believe that it could rise early in 2010.
Phillip Shaw, economist at Investec Securities, explains: "CPI inflation looks set to continue to fall sharply and we expect it to bottom out at close to 0.5% during the autumn.
"Thereafter the planned return of VAT to 17.5% from 15% in January 2010 will push inflation up above 2% for a while, although given that not all of last year’s reduction was passed through, it is reasonable to suppose that the upside may also be constrained."
However, Shaw adds that inflation should still remain below its 2% target throughout most of 2010 and 2011.
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).
Does exactly what it says on the tin: covers the contents of your home for theft and damage and also may insure certain possessions (jewellery, cycles) outside of the home. Things to watch for include the excess and also the maximum payout on individual items. Another grey area is kitchen fittings, as some contents policies say these are not contents but part of the fabric of the property and covered by buildings insurance and some buildings policies don’t cover them because they regard them as contents.
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.