The Consumer Prices Index (CPI) rate of inflation has remained stubbornly low for several years now. At the end of last year, the CPI stood at just 1.6%, a record low and well below the Bank of England’s target of 2% annual inflation. And yet, in recent months there have been signs that it may be coming down further than many people realize. For example, in September Statistics New Zealand announced that its measure of consumer prices fell by 0.3% during the third quarter of 2018 — its biggest drop on record for any quarter. In response to these developments, many commentators have begun asking whether we are seeing the beginning of a once-in-a-century deflationary period such as occurred during the Great Depression in 1929 and again in the 1930s.
How is the CPI calculated?
The CPI is the most widely used measure of inflation across the world. It is a measure of the average change in prices for goods and services for a typical household. The items that are included in the CPI are chosen to represent a wide cross-section of what people buy, such as food, clothing, transport and rent. The CPI is calculated each month by surveying around 60,000 households to find out what they have been spending money on, and then comparing those figures with the costs of the same goods and services from a year earlier.
Recent developments that may cause UK inflation to rise
One of the main reasons why the CPI has been low for so long is that energy and food costs have been falling. However, in recent months there have been signs that energy costs are beginning to rise again, and that food prices may not fall as far as expected. But perhaps the most significant development has been the increase in the prices of imported goods in recent months. One of the major factors behind the low CPI has been the fall in the value of the pound since the Brexit vote in June 2016. This has made imports into the UK more expensive, so they have been priced at a higher level. But the value of the pound has risen since the beginning of the year, making UK goods cheaper for foreign buyers, and vice versa. So, many of the goods that have been causing the CPI to fall have now stopped falling as much, or in some cases have actually started to rise.
Why a small fall in the CPI may not be good news
One of the things that people often forget about the CPI is that a very low reading is not necessarily good news. In fact, the ideal rate of inflation is 0%, as any positive rate is harmful to economic growth. Unfortunately, the CPI has remained persistently below the 2% mark for years now, to such an extent that the Bank of England has been seriously considering taking action to boost inflation back up. The main reason why the Bank has been so eager to see the CPI rise is that it has a target of 2% annual inflation. But the CPI is not the only measure of inflation, and it is one that is much more relevant to households than the Bank’s main target. This is because the CPI is the inflation rate that households experience, whereas the target rate is the level of inflation that is necessary for the Bank to maintain its policy of steady economic growth.
The danger of false optimism
The danger of not paying due attention to the CPI while waiting for it to rise to the 2% target is that when it finally happens, it may happen too fast. This may lead the Governor of the Bank of England, Mark Carney, to raise interest rates more quickly than he otherwise would, thereby slowing down economic growth. All of this is not to say that people should not hope for a fall in the CPI. Indeed, a further fall in the rate remains a real possibility, especially if energy costs continue to rise. The only warning is that many people may be expecting too much, too soon in terms of a fall in the CPI. However, if the CPI does not fall any further, or even starts to rise again, it will give the Bank of England all the excuse it needs to keep interest rates at their current low level, and let the economy continue to grow at its own pace.
Conclusion
In the past few years, the CPI has remained stubbornly low, falling below the 2% target set by the Bank of England. As a result, many commentators have begun asking whether we are seeing the beginning of a once-in-a-century deflationary period such as occurred during the Great Depression in 1929 and again in the 1930s. However, there have been signs that it may be coming down further than many people realize. One of the main reasons why the CPI has been low for so long is that energy and food costs have been falling. However, in recent months there have been signs that energy costs are beginning to rise again, and that food prices may not fall as far as expected. Across the world, the CPI is the most widely used measure of inflation. It is a measure of the average change in prices for goods and services for a typical household. In the UK, it is calculated each month by surveying around 60,000 households to find out what they have been spending money on, and then comparing those figures with the costs of the same goods and services from a year earlier.