Inflation Explained - How it affects you
10 April 2007
Reader Writes:
I notice there are a few explanations on inflation and wonder what is the difference between them. Clearly the government have a target but what is it and how does it affect me?
The target inflation for the government is the CPI, which is the Consumer Price Index. Internationally it is known as the Harmonised Index of Consumer Prices (HICP) but the two measures are one and the same. This measure is used for international comparisons.
The Retail Price Index (RPI) is slightly different. It is the most familiar measure domestically but it covers a different range of goods and services. You’ll often see it referred to as the headline rate of inflation and is the most often used measure for up rating of pensions by the government and the rate most cited by the unions when dealing with pay settlements etc.
The CPI is different to the RPI in that it excludes certain housing costs such as mortgage interest payments and council tax. On that basis you could say that it’s not a real measure as these payments have a large impact on outgoings. The CPI also includes certain items such as charges for financial services, whereas the RPI does not. The CPI does, however cover a broader sample of the population than the RPI.
The focus is to identify the cost of a basket of goods to the customer. This will give an indication of the rising costs to the consumer and in turn gives us the inflationary figure. The measure is probably as accurate as it can be in that includes over 120,000 separate price quotations calculated each month covering some 650 representative goods across 150 areas in the UK. (1) It’s also natural that certain goods will carry a heavier weighting, reflecting the fact we spend more on these items. Different spending patterns will have an effect, so each year the basket of goods is rebalanced. In simple terms, in certain years we may go mad for a new TV before a large sporting occasion, whereas in others we may go mad for petrol (petrol shortage).
In his speech in December 2003, Mr Brown said the inflation target would be switched to the CPI with immediate effect. The three reasons given were that it gave a more realistic characterisation of consumer behaviour; a better picture of spending patterns in the UK and it was a more comparable international comparison.
Interestingly the government gave the Bank of England independence ten years ago to set interest rates, but also set it a CPI target of 2%. Although it allows a variance of 1% each way, the Bank of England will use interest rates to slow down spending patterns when it is worried about an economy overheating or alternatively deflating. Currently CPI sits at 2.8%, (2) so we can easily see why rates have begun to rise. It is often said the impact of rate rises take around eighteen months to have their full impact, so panic never really sets in when CPI continues to rise after interest rates have been increased.
The governor of the Bank of England must write to the chancellor if the CPI breaks out of the variance of 1% each way of the 2% target – ‘I’m really sorry and wont do it again wouldn’t be an acceptable love letter.’
Every month the Bank of England meet to decide on interest rates. Whilst many commentators view us as being in a rising interest rate environment, the last vote showed a split with David Blanch flower voting for a cut against eight voting for rates to stay the same.
The recent budget of course introduced a few price hikes and they will naturally have an impact on inflation. The impact is likely to be 0.19% on the CPI which is broadly the same as last year, whilst the impact on the RPI is expected to be 0.22% (3)
If you have a financial query call 0845 230 9876 or email info@wwfp.net
Sources
(1) http://www.statistics.gov.uk/articles/nojournal/CPI&RPI_basket_2007.pdf
various other sources relate to http://news.bbc.co.uk/1/hi/business/6356475.stm
(2) http://www.statistics.gov.uk/pdfdir/cpi0307.pdf
(3) http://www.statistics.gov.uk/articles/nojournal/BudgetNote2007.pdf
Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.
10/04/07
Reader Writes:
I notice there are a few explanations on inflation and wonder what is the difference between them. Clearly the government have a target but what is it and how does it affect me?
The target inflation for the government is the CPI, which is the Consumer Price Index. Internationally it is known as the Harmonised Index of Consumer Prices (HICP) but the two measures are one and the same. This measure is used for international comparisons.
The Retail Price Index (RPI) is slightly different. It is the most familiar measure domestically but it covers a different range of goods and services. You’ll often see it referred to as the headline rate of inflation and is the most often used measure for up rating of pensions by the government and the rate most cited by the unions when dealing with pay settlements etc.
The CPI is different to the RPI in that it excludes certain housing costs such as mortgage interest payments and council tax. On that basis you could say that it’s not a real measure as these payments have a large impact on outgoings. The CPI also includes certain items such as charges for financial services, whereas the RPI does not. The CPI does, however cover a broader sample of the population than the RPI.
The focus is to identify the cost of a basket of goods to the customer. This will give an indication of the rising costs to the consumer and in turn gives us the inflationary figure. The measure is probably as accurate as it can be in that includes over 120,000 separate price quotations calculated each month covering some 650 representative goods across 150 areas in the UK. (1) It’s also natural that certain goods will carry a heavier weighting, reflecting the fact we spend more on these items. Different spending patterns will have an effect, so each year the basket of goods is rebalanced. In simple terms, in certain years we may go mad for a new TV before a large sporting occasion, whereas in others we may go mad for petrol (petrol shortage).
In his speech in December 2003, Mr Brown said the inflation target would be switched to the CPI with immediate effect. The three reasons given were that it gave a more realistic characterisation of consumer behaviour; a better picture of spending patterns in the UK and it was a more comparable international comparison.
Interestingly the government gave the Bank of England independence ten years ago to set interest rates, but also set it a CPI target of 2%. Although it allows a variance of 1% each way, the Bank of England will use interest rates to slow down spending patterns when it is worried about an economy overheating or alternatively deflating. Currently CPI sits at 2.8%, (2) so we can easily see why rates have begun to rise. It is often said the impact of rate rises take around eighteen months to have their full impact, so panic never really sets in when CPI continues to rise after interest rates have been increased.
The governor of the Bank of England must write to the chancellor if the CPI breaks out of the variance of 1% each way of the 2% target – ‘I’m really sorry and wont do it again wouldn’t be an acceptable love letter.’
Every month the Bank of England meet to decide on interest rates. Whilst many commentators view us as being in a rising interest rate environment, the last vote showed a split with David Blanch flower voting for a cut against eight voting for rates to stay the same.
The recent budget of course introduced a few price hikes and they will naturally have an impact on inflation. The impact is likely to be 0.19% on the CPI which is broadly the same as last year, whilst the impact on the RPI is expected to be 0.22% (3)
If you have a financial query call 0845 230 9876 or email info@wwfp.net
Sources
(1) http://www.statistics.gov.uk/articles/nojournal/CPI&RPI_basket_2007.pdf
various other sources relate to http://news.bbc.co.uk/1/hi/business/6356475.stm
(2) http://www.statistics.gov.uk/pdfdir/cpi0307.pdf
(3) http://www.statistics.gov.uk/articles/nojournal/BudgetNote2007.pdf
Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.
10/04/07
'Your home may be repossessed if you do not keep up repayments on your mortgage'.
'Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. Worldwide is entered on the FSA register www.fsa.gov.uk/register/ under reference 440668
Registered office; The Old Carriage Works, Moresk Road, Truro, Cornwall, TR1 1DG. Registered in England and Wales No. 3533548. Contact info@wwfp.net or 01872 222 422
© 2007 Worldwide Financial Planning - this site is intended for UK investors only
By clicking on any of the external links within this website you will leave the regulatory site of Worldwide Financial Planning Ltd. Worldwide Financial Planning Ltd are not responsible for the accuracy of the information contained within the linked sites.'
'Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. Worldwide is entered on the FSA register www.fsa.gov.uk/register/ under reference 440668
Registered office; The Old Carriage Works, Moresk Road, Truro, Cornwall, TR1 1DG. Registered in England and Wales No. 3533548. Contact info@wwfp.net or 01872 222 422
© 2007 Worldwide Financial Planning - this site is intended for UK investors only
By clicking on any of the external links within this website you will leave the regulatory site of Worldwide Financial Planning Ltd. Worldwide Financial Planning Ltd are not responsible for the accuracy of the information contained within the linked sites.'