Cost of living soars to 14-month high
The headline rate of inflation soared to a 14-month high in January as VAT returned to its standard rate of 17.5%.
The Consumer Prices Index (CPI) - the official measure of the cost of living - jumped to 3.5% last month, from 2.9% in December.
The year-long VAT cut to 15% came to an end on 31 December, lifting the price of alcohol, tobacco, hotels and restaurants.
The higher cost of crude oil from a year ago has also pushed up the price of petrol and other transport costs, while retailers offered lower discounts in the post-Christmas clearance sales this January.
The spike in inflation means the Mervyn King, governor of the Bank of England, must write a letter to the chancellor explaining why inflation has shot up by more than 1% above the Bank’s medium-term target of 2%.
This will mark the sixth time he has been forced to do so since 2007.
Meanwhile, the Retail Price Index (RPI) - which some economists say is a more accurate measure of inflation as it includes housing costs - has risen from 2.4% to 3.7%.
Start of a trend
Economists are now predicting that inflation will rise further in February as more retailers pass on January’s VAT hike - although this is expected to drop back in the second half of the year.
Howard Archer, chief UK and European economist at IHS Global Insight, says: “Given the extent of the spike up since last September, there is obviously the risk that inflation could be stickier than expected and not fall back as much or as quickly as hoped.
"Nevertheless, we believe consumer price inflation could well be back under 2% by the end of the year and then largely stay there during 2011.”
The Bank of England recently indicated that it expected inflation to peak at 3.5% before falling back below 2% later this year.
The news that inflation has risen so sharply will come as a blow to savers - as a lack of competitive savings rates mean it is tough to find a new account that can keep up with inflation.
A basic-rate taxpayer currently needs to find a savings account that pays at least 4.38% in interest to stop their savings pot eroding away. A higher-rate taxpayer has to earn at least 5.83% - however, there are currently no fixed-rate bonds paying interest above 5.83%, according to data provider Moneyfacts.
“Each month, inflation is cutting deeper into people’s spending power and lower savings interest rates are creating an even bitterer pill to swallow," Darren Cook, spokesman for Moneyfacts.
"Those who are relying on their savings pot to subsidise other income are seeing their savings being eroded on average by 2.92% per year for a basic-rate taxpayer and 3.06% for a higher-rate taxpayer."
The average instant access account currently pays just 0.86% - which equates to 0.69% for a basic-rate taxpayer and only 0.52% for a higher-rate taxpayer.
David Black, banking specialist at Defaqto, say: “The stark reality is that there are now no taxable instant access or notice accounts that will give a real rate of return to even a basic-rate taxpayer let alone a higher-rate taxpayer.
Even when it comes to tax-free cash ISAs, Black says there are only 39 available that pay a real rate of return based on RPI inflation for a £3,600 balance.
“Savers have to be incredibly proactive to get the best deals and, apart from some cash ISAs, the only bank and building society savings accounts that give the higher-rate taxpayer any chance of a real rate of return are a handful of regular savings and current accounts as well as a few fixed-rate bonds that require linked investments in the stockmarket," he adds.
"The total number of such accounts barely reaches double figures and many of them have conditional additional requirements. Those reliant on savings interest to supplement inadequate income will be devastated by this double whammy of rising inflation and low interest rates."
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.
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.
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).
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
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).