Has inflation peaked?
The headline rate of inflation fell sharply last month for the first time since September - raising hopes that inflation may have peaked.
Utility price cuts and a slower rise in food prices helped to send the Consumer Prices Index (CPI) - the official measure of inflation - down to 3% in February.
This follows it soaring to a 14-month high of 3.5% in January - well above the Bank of England’s 2% target.
There have been fears that measures such as quantitative easing (the creation of new money) and the record-low interest rate could cause a spike in inflation. But economists now say the larger-than-expected fall in February should help to bring some comfort that underlying prices in the UK economy remain pretty subdued.
While the VAT reversal, increasing commodity prices and the sterling depreciation are stimulating inflation, most economists believe it will fall in the coming months.
Jonathan Loynes, chief European economist at Capital Economics, predicts that while inflation is likely to hover at current levels for the next few months, it should fall back “sharply” later this year and in 2011.
As such, he says the Bank of England may keep the interest rate low for some time.
Howard Archer, chief UK economist at IHS Global Insight, also believes that while CPI could rise further in the short term, it will fall to under 2% by the end of the year.
“Given that oil prices bottomed out early in 2009 and then firmed, base effects will become more favourable,” he explains.
“Meanwhile, underlying price pressures should be contained by substantial excess capacity, likely bumpy and gradual recovery, wage moderation amid high unemployment and job insecurity, and the need for retailers to price competitively in the face of still limited consumer spending.”
Despite the fall in CPI, savers are still suffering from the erosive impact inflation has.
A basic-rate taxpayer needs to find an account paying 3.75%, while a higher-rate taxpayer needs to find an account paying 4.98%, in order to beat inflation.
Michelle Slade, spokesperson for Moneyfacts, says: “ Despite the fall, inflation continues to erode the value of savers’ money and with rates also declining, savers are being dealt a double blow.
“Prudent savers are being neglected and are finding it virtually impossible to combat the effects of tax and inflation.”
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.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
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).
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).