Tag: CPI inflation rate

In two recent blogs we have analysed the headache facing the Monetary Policy Committee, given the persistence of inflationary pressures in the UK economy, in deciding whether to raise interest rates. In Food for thought, Elizabeth Jones describes how, despite the weakness of aggregate demand, cost pressures have fuelled inflation while John Sloman in Time for a rise in Bank Rate looks at the difficult judgement call for the MPC in risking a marked dampening of aggregate demand by raising rates while, on the other hand, failing to dampen inflationary expectations by not raising rates. In this blog Dean Garratt analyses some of the latest inflation figures as detailed in the latest Consumer Price Indices Statistical Bulletin. In particular, he focuses on the inflation rates within the overall consumer price inflation rate.

You might be wondering what we mean when we refer to inflation rates within the overall inflation rate. In answering this we need to consider how the Office for National Statistics goes about estimating the Consumer Price Index (CPI) and the CPI inflation rate (further details are available in Consumer Price Indices – A Brief Guide produced by the ONS). In order to compile the Consumer Price Index (CPI), each month an organisation collects on behalf of the ONS something in the region of 110,000 prices quotations for around 560 items. But, the key point is that these goods and services fall into one of 12 broad product groups which are referred to as level 1 product groups. These include, for example, food and non-alcoholic beverages and transport.

The items included in each of the 12 product groups are reviewed once a year so that the chosen items remain representative of today’s spending patterns. Once the price information for our representative goods and services has been collected, the prices are compared with their levels in the previous January and the change recorded. These changes are then aggregated in both each product group and across all groups. The price changes are aggregated by weighting them according to the typical share of household spending that each good or service represents. This process is repeated each month in the year so as to always calculate the aggregate change in prices since January. The final step is to link the price changes with those from earlier years to form one long price index, both for each product group and for the overall shopping basket, so that at one arbitrary moment in time the index takes a value of 100.

Once we have our price indices we can calculate annual rates of price inflation. The annual rate of CPI inflation in December 2010 is recorded at 3.7%. This means that the Consumer Price Index was 3.7% higher in December 2010 than it was December 2009. Similarly, the annual rate of CPI inflation in November 2010 of 3.3% means that consumer prices rose by 3.3% between November 2009 and November 2010. Across 2010 as a whole the CPI rose by 3.3%, so in excess of the Bank of England’s inflation rate target range, and significantly up on the 2.2% across 2009. The Bank has a symmetrical inflation rate target of 2% plus or minus 1 percentage point (you may want to read more about the Bank’s Monetary Policy Framework).

Let’s look to delve deeper because price indices are also available for product groups at two lower levels known as level 2 and level 3 product groups. For example, from within the food and non-alcoholic beverages group there is a price index wholly for food and within this one for vegetables. Again annual rates of price inflation can be found for level 2 and level 3 product groups.

If we consider food and non-alcoholic beverages we find an annual rate of price inflation for December of 6.1%. This was its highest annual rate since May 2009. Across 2010 as a whole we find that prices rose by 3.4%, very much in accordance with the overall CPI inflation rate. Inflationary pressures within this category are not new with 2008 seeing prices rises by 9.1% as compared with 3.6% for the overall CPI inflation rate. Over the past 5 years, food and non-alcoholic beverage inflation has typically been running at an annual rate of 5% while overall consumer price inflation has been running at 2.8%.

If we now focus on food alone, we find an annual rate of food price inflation in December of 5.7%. While this is a little lower than with the inclusion of non-alcoholic beverages, it is nonetheless a full 2 percentage points above the overall CPI inflation rate. Across the year as a whole food price inflation comes in bang on 3% highlighting the extent of the inflationary pressures in more recent months. This, however, still falls some way short of the pressures seen in 2008 when food prices rose by 10.1%. If we drop to level 3 to focus on groups within the food category we find inflation rates for oils and fats of 11%, for fish of 9% and for fruit of 8.6%.

Within the 12 broad groups the highest annual rate of price inflation is currently to be found for transport where the annual rate of price inflation in December was 6.5%. Across 2010, transport prices rose by 8.3% which compares a tad unfavourably with the 0.8% increase seen in 2009. If we drop down to the level 3 groups within this category we can trace the source of the price pressures more readily. The cost of air passenger transport in December was up over 12 months by 13.5% and, you may not be surprised to learn, the cost of fuel and lubricants was up by 12.9%.

We finish by noting the only level 1 category to see prices fall across 2010: clothing and footwear. This product group saw prices fall by 1% in 2010. But, even here price pressures have emerged. Between April 1992 and August 2010 clothing and footwear consistently recorded annual rates of price deflation. Since September this has ceased with positive annual rates of inflation. The annual rate of inflation for clothing and footwear in December was estimated at 1.5%. Perhaps those socks in my bottom drawer really will have to last me just a little bit longer!

Articles

Inflation is a blip says Bootle BBC News (21/1/11)
Fuel prices could rise by 4p in April BBC News (22/1/11)
Paul Lewis: Why inflation is starting to buy BBC News (20/1/11)
High levels of inflation remains a worry for Beijing BBC News (20/1/11)
Inflation ‘biggest money worry for families’ BBC News (19/1/11)
UK inflation rate rises to 3.7% BBC News (18/1/11)
Inflation hysterics Financial Times (19/1/11)
Top investors raise alarm on inflation Financial Times, Richard Milne, Dan McCrum and Robert Cookson (21/1/11) )
Inflation hits 3.7% after record monthly increase Guardian UK, Graeme Wearden (18/1/11)
We knew inflation would be bad, but not this bad Guardian, Larry Elliott (18/1/11)
The mystery of clothes inflation and the formula effect The Economist (21/1/11)

Data

Latest on inflation Office for National Statistics (18/1/11)
Consumer Price Indices, Statistical Bulletin, March 2010 Office for National Statistics (18/1/11)
Consumer Price Indices, Time Series Data Office for National Statistics
For CPI (Harmonised Index of Consumer Prices) data for EU countries, see:
HICP European Central Bank

Questions

  1. Describe the process of compiling the Consumer Price Index (CPI). Are we comparing the cost of the same basket of goods and services across years? What about within a given year? (Further details are available in Consumer Price Indices – A Brief Guide).
  2. Explain the difference between an increase in the level of prices and an increase in the rate of price inflation. Can the rate of price inflation fall even if price levels are rising? Explain your answer.
  3. Why do you think policy-makers, such as the Monetary Policy Committee, would be interested in the inflation rates within the overall CPI inflation rate?
  4. What factors do you think lie behind the pressures on; (i) food prices; (ii) clothes prices; and (iii) transport prices? How would your answers help to inform how you would vote on interest rates if you were on the Monetary Policy Committee?
  5. The following are the consumer price index values for all items, food and non-alcoholic beverages, clothing and footwear and transport in 1988, 2009 and 2010. Use these values to calculate the percentage change between 1988 and 2010 and those between 2009 and 2010. Comment on your findings.
    All items: 1988= 63.5; 2009= 110.8; 2010= 114.5
    Food and non-alcoholic beverages: 1988= 68.2; 2009= 123.2; 2010= 127.4
    Clothing and footwear: 1988= 163.8; 2009= 79.6; 2010= 78.8
    Transport: 1988= 55.4; 2009= 112.7; 2010= 122.1
  6. How serious an economic issue do you think inflation is? Illustrate your answer drawing on real-world examples of the impact of inflation.

Letter writing has, in many walks of life, rather gone out of fashion. For instance, many of us of a slightly older disposition remember how putting pen to paper was an important part of courtship and the building of relationships. Well, one modern-day couple who are getting very used to an exchange of letters is the Governor of the Bank of England and the Chancellor of the Exchequer. The latest inflation numbers from the Office for National Statistics show that the annual rate of CPI inflation for July was 3.1%. While the inflation rate is down from the 3.2% recorded in June it remains more than 1 percentage point above the government’s central inflation rate target of 2%. Consequently, Mervyn King will again be writing to the Chancellor to explain why this is the case.

Since the turn of the year, the annual rate of CPI inflation has, with the exception of February, been consistently above 3%. Even February was a narrow escape for the Governor because inflation came in at exactly 3%! Another way of putting the recent inflation record into perspective is to note that over the first seven months of 2010 the average annual rate of CPI inflation has been 3.3%.

The slight fall in July’s annual inflation rate is attributed, in part, to falls during July in the prices of second-hand cars and petrol whereas these prices were rising a year ago. Furthermore, the average price of clothing and footwear fell by some 4.9% between June and July of this year as compared with a fall of 3.2% in the same period a year ago. The result is that the annual rate of price deflation for clothing and footwear went from 1.4% in June to 3.1% in July.

Of course, within the basket of consumer goods price patterns can vary significantly. One significant upward pressure on July’s overall annual inflation rate was the price of food and non-alcoholic beverages, especially vegetables. The average price of food and non-alcoholic beverages rose by 1% between June and July which has seen the annual rate of price inflation for food and non-alcoholic beverages rise from 1.9% in June to 3.4% in July.

The fact that July shows inflation running in excess of 3% will surprise very few. In the latest Inflation Report the Bank of England reports that the Monetary Policy Committee’s view is that ‘the forthcoming increase in VAT was expected to keep CPI inflation above the 2% target until the end of 2011’. The Committee then expects what it describes as a ‘persistent margin of spare capacity’ to force inflation to fall back. But, the Committee also feels that the prospects for inflation are ‘highly uncertain’. Therefore, it is difficult to gauge just how many more letters will be passing across London between the Governor and the Chancellor in the coming months. Nonetheless, it would be probably be advisable for the Governor to make sure that he has a sufficient supply of postage stamps at his disposal, just in case!

Articles

UK inflation rate slows again in July BBC News (17/8/10)
Bank of England’s King forced to write another letter to Osborne as prices stay high Telegraph (17/8/10)
Inflation falls to 3.1% in July Financial Times, Daniel Pimlott (17/8/10)
Dearer food keeps inflation high UK Press Association (17/8/10)
Bank ‘surprised’ at inflation strength Independent, Russell Lynch (17/8/10)

Letters
Letter from the Governor to the Chancellor and the Chancellor’s reply Bank of England (17/8/10)

Data

Latest on inflation Office for National Statistics (17/8/10)
Consumer Price Indices, Statistical Bulletin, July 2010 Office for National Statistics (17/8/10)
Consumer Price Indices, Time Series Data Office for National Statistics
For CPI (Harmonised Index of Consumer Prices) data for EU countries, see:
HICP European Central Bank

Questions

  1. What does the Bank of England mean by a ‘persistent margin of spare capacity’? By what economic term is this phenomenon more commonly known?
  2. Why do you think the current rate of inflation is above target despite the spare capacity in the economy?
  3. Since the annual rate of CPI inflation remains in ‘letter-writing territory’ would you expect the Monetary Policy Committee to be raising interest rates some time soon? Explain your answer.
  4. What impact might the persistence of above-target inflation have for the public’s expectations of inflation?
  5. What impact can we expect the increase in the standard rate of VAT next January to have on the annual rate of CPI inflation? Is such an effect on the rate of inflation a permanent one?

For some, thoughts will have turned to events on football pitches in South Africa. Perhaps though we should spare a thought for the Governor of the Bank of England, Mervyn King, who is likely to be concerned by his own team’s recent performance in missing the inflation rate target! Mervyn’s resulting ‘yellow card’ involves writing a letter to the Chancellor of the Exchequer every time the annual rate of CPI (Consumer Price Index) inflation deviates by more than one percentage point from the government’s central target of 2%. Unfortunately for the Governor, since the turn of the year, only in February has the annual rate of CPI inflation failed to exceed 3%. And, even that was within in a whisker of missing the goal since the rate of inflation squeaked in at 3%. Perhaps February was more a case of hitting the post!

As all sports fans know, a run of disappointing results can lead to dissent amongst players and supporters alike. We can see from the minutes of June’s meeting of the Monetary Policy Committee the extent of the debate over the persistence of inflation. The debate included discussions concerning the impact of the expected fiscal consolidation measures (the MPC met before the Budget), the public’s higher inflation rate expectations, the price of oil and other commodities and the margin of spare capacity in the economy (the output gap). The minutes reveal that one member of the MPC, Andrew Sentance, voted for an increase in interest rates believing that inflation had been particularly resilient in the aftermath of the recession.

We now have new forecaster in town: The Office of Budget Responsibility. In our blog article Who’d be a forecaster? A taxing time for the new OBR we looked at the growth forecasts produced by the Office of Budget Responsibility taking into account the Budget Measures of 22 June. The June 2010 OBR Budget forecasts also contain predictions for CPI inflation. So what do the OBR say?

The OBR predicts that the annual rate of CPI inflation will stay around 3% in the near term. It is now slightly more pessimistic about the prospects for inflation beyond the near term than it was in its pre-Budget forecasts. More specifically, it says that CPI inflation will ‘decline more gradually’ than first thought because of the rise in the standard rate of VAT to 20% in January 2001 and its belief that oil prices will be higher than originally envisaged. The OBR is forecasting the average price of a barrel of oil in 2010/11 to be $78 rising to $82 in 2011/12.

Going further ahead, the OBR expects the rate of inflation to fall back to ‘a little under 2 per cent in early 2012’. It argues that this will reflect the unwinding of the VAT effect, and, significantly, the downward pressure on prices from the larger negative output gap that will result from the fiscal consolidation measures in the Budget. In other words, the expectation is that there will be greater slack or spare capacity in the economy which will help to subdue price pressures.

If the OBR is right, the Governor may have more letter-writing to do in the near term and perhaps well into 2011. But, the fiscal consolidation measures should, once the impact of the VAT rise on the inflation figures ‘drops out’, see the rate of inflation fall back. Perhaps then, the final whistle can be blown on the Governor’s inflation troubles. In the mean time it will be interesting to see how MPC members take on board, in their deliberations over interest rates, the Budget measures and the OBR’s own thoughts on inflation. Could interest rates be rising shortly despite fiscal consolidation? Let Mervyn and his team play on!

OBR Forecasts
Budget Forecast June 2010 OBR (22/6/10)
Pre-Budget Forecast June 2010 OBR (14/6/10)

Monetary Policy Committee
Overview of the Monetary Policy Committee
Monetary Policy Committee Minutes

Inflation Data
Latest on inflation Office for National Statistics (15/6/10)
Consumer Price Indices, Statistical Bulletin, May 2010 Office for National Statistics (15/6/10)
Consumer Price Indices, Time Series Data Office for National Statistics
For CPI (Harmonised Index of Consumer Prices) data for EU countries, see:
HICP European Central Bank

Articles

MPC minutes reveal Bank split on inflation risk Financial Times, Daniel Pimlott (23/6/10)
Bank of England minutes reveal surprise split on interest rates Guardian, Katie Allen (23/6/10)
Instant view: Bank split 7-1 on June vote Reuters UK (23/6/10)
Now even the Bank isn’t sure it can bring down inflation Independent, Sean O’Grady (24/6/10)
An inflation hawk hovers over the Bank of England Guardian, Nils Pratley (24/6/10)

Questions

  1. Explain why an output gap – the amount of spare capacity in the economy – might impact on price pressures.
  2. What impact would you expect the rise in the standard rate of VAT next January to have on the CPI (price level) and on the CPI inflation rate? What about the following year?
  3. Some economists believe that by being more aggressive in cutting the fiscal deficit, interest rates will be lower than they otherwise would have been. Evaluate this argument.
  4. Now for your turn to be a member of the MPC and to decide on interest rates! How would you vote next month? Are you a ‘dove’ or a ‘hawk’?

The latest inflation numbers are a joy for headline writers! With the falling price of toys, we can perhaps speak of ‘inflation toying with us’, while the fall in the cost of gas might allow us to say that ‘gas takes the fuel out of inflation’. More generally, the latest inflation figures from the Office for National Statistics (ONS) show the annual rate of CPI inflation falling from 3.5% in January to 3% in February. In other words, the weighted price of a representative basket of consumer goods and services rose by 3% in the 12 months to February as compared with 3.5% over the 12 months to January.

In compiling the Consumer Price Index (CPI), the ONS collects something in the range of 180,000 price quotations over 650 representative goods and services. These goods and services fall into 12 broad product groups. The items to be selected for these groups are reviewed once a year so that, in the face of changing tastes and preferences and changes in the goods and services available to us, the ‘CPI shopping basket’ remains representative. A price index and a rate of price inflation are available for each of these 12 broad groups as well as for goods and services within these groups. So, for instance, we can obtain a price for ‘transport’, then, within this group, we can obtain a price for the purchase of ‘vehicles’ and, finally, a price for ‘new cars’ and for ‘second-hand cars’. This level of detail also means that individuals can calculate their own personal inflation rates using the ONS personal inflation calculator.

So what of the latest fall in the rate of CPI inflation? Well, the ONS reports ‘widespread’ downward pressures. This phrase needs some careful unpicking. Downward pressure is reported from ‘recreation and culture’ because its average price was static in February, but rose a year earlier. Within this group, the average price of games, toys and hobbies fell this year, but increased a year ago and, so, our possible headline ‘inflation is toying with us’. Similarly, downward pressure is reported from ‘housing and household services’ where a fall in its average price this year follows static prices a year ago. A major driver of this change was a reduction in average gas bills and so our other possible headline, ‘gas takes the fuel out of inflation’.

The latest price numbers from the ONS show that some product groups are experiencing long-term price deflation. For instance, while the average price of ‘clothing and footwear’ actually rose in February, when we analyse annual rates of price inflation for this product group, one has to go back to March 1992 to find the last time it was positive! Indeed, within the slightly narrower product group of ‘clothing’, the average annual rate of price deflation over the past ten years has been 6.1%. A similar longer-term trend of price deflation can be found in the product group ‘audio-visual, photo and data processing’. Here there has been an average annual rate of price deflation of 9.9% over the past ten years. So, smile for the camera!

Articles

Rates set to remain at record low as inflation falls back sharply heraldscotland, Ian McConnell (23/3/10)
Inflation data boosts government before budget AFP (23/3/10)
UK inflation rate falls to 3% in February BBC News (23/3/10) )
Inflation slows more than expected Reuters UK, David Milliken and Christina Fincher (23/3/10)
UK inflation falls sharply to 3% Financial Times, Daniel Pimlott (23/3/10)
Inflation rate fell to 3 per cent in February Independent. James Moore (24/3/10)
Inflation falls back to 3% Guardian, Philip Inman (23/3/10)
How soon before we scrap the Bank’s inflation target? Telegraph, Edmund Conway (23/3/10)

Data

Latest on inflation Office for National Statistics (23/3/10)
Consumer Price Indices, Statistical Bulletin, March 2010 Office for National Statistics (23/3/10)
Consumer Price Indices, Time Series Data Office for National Statistics
For CPI (Harmonised Index of Consumer Prices) data for EU countries, see:
HICP European Central Bank

Questions

  1. Explain the difference between an increase in the level of prices and an increase in the rate of price inflation.
  2. The annual rate of price inflation for clothing in February was -3.9%. If the average price of clothing was cheaper, year-on-year, how could it have exerted ‘upward’ pressure on the overall rate of CPI inflation?
  3. What factors might help to explain why, over the past 10 years, the average annual rate of price inflation for audio-visual, photo and data processing equipment has been -9.9%?
  4. What factors might help to explain why, over the past 10 years, the average annual rate of price inflation for clothing and footwear has been -5.7%?
  5. What factors might help to explain why the annual rate of ‘new car’ price inflation was 5.4% in February 2010 compared with -0.2% in February 2009?
  6. What factors might help to explain why the annual rate of ‘second-hand’ car price inflation was 19.0% in February 2010 compared with -15.1% in February 2009? And, are you surprised at the difference in the rates of ‘new’ and ‘second-hand’ car price inflation?