5 min Read
23 Mar 2010

Written by Damien

Damien is one of the most widely quoted money and investment experts in the national press and has made numerous radio & TV appearances. He created MoneytotheMasses.com while working in the City when he became disillusioned with the way the public were left to fend for themselves because they could not afford financial advice.

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Inflation falls back to 3% allaying interest rate rise fears

The UK inflation rate fell to 3% in February from 3.5% the month before, official figures have shown. The key facts are:

  • The drop in the Consumer Prices Index (CPI) inflation rate was greater than the sharp drop analysts had expected.
  • Retail Prices Index (RPI) inflation, which includes housing costs, remained unchanged at 3.7% in February.

But what does this all mean? And what’s the difference between CPI and RPI?

Both the CPI and RPI are attempts to estimate inflation in the UK. The RPI measure is arguably the better known in the UK. Sometimes referred to as the "headline" rate of inflation, it is the rate often cited by unions as a benchmark for agreeing pay settlements. It is also the basis for pension increase and National Savings Index linked investments

The CPI measure is the rate the government's inflation target is based on. It is an internationally comparable measure of inflation

Both indexes analyse the prices changes of a range of goods and services over time (referred to as the ‘basket’). Some of the goods and services will carry a higher weighting within the indexes, reflecting the fact that we spend more on some items than others. In addition, the actual items which are included in the basket are reviewed each year and are subject to change.

So why do the CPI and RPI values differ?

The answer is that the two measures cover different items. For example, the CPI does not include Council Tax, mortgage interest payments and some other housing costs. The CPI measure also includes some items such as charges for financial services which are not in the RPI. Another difference is that the CPI measure covers a broader sample of the population in its calculations than RPI.

There is also a difference in the mathematics of each index which means that the CPI is always lower than RPI for a given data sample.

So is it good news that CPI is down more than expected and RPI has stayed the same? And when will interest rates go up?

While it’s too early to bring out the party poppers, as stated above, the Bank of England uses the CPI as its inflation measure when making interest rate decisions. The news that the CPI has fallen quicker than Mervyn King anticipated coupled with his recent comments on the UK economy not being out of the woods might suggest that interest rate rises will still be some time off, maybe even next year. This will be good news for home owners and people with debt

However, savers won’t be too happy as inflation will devalue their deposits while they earn next to nothing on them, The fact that RPI has not fallen is good news for pensioners on the one hand as state pension increases are linked to RPI, but bad news on the other as the state pension is set to increase by just 2.5% in April (state pension increase use the previous September’s RPI rate).

But, before everyone gets carried away, today’s figures are just a snapshot and offer no certainty as to the ultimate direction of prices. While on the face of it  this Headline is good news, particularly as it at least confirms that the Bank of England have some sort of grasp on where the economy may be going, inflation could come back with a vengeance. With petrol price increases around the corner (see previous post), an over reliance on exports and weak pound inflation concerns could be back on top of the agenda very soon. And one final point, remember these indexes are general measures of inflation. If you spend your life driving a car while buying luxury items you will find life a hell of a lot more expensive than this time last year.

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