The lowest inflation rate for nearly two years - why should you care?

The lowest inflation rate for nearly two years - why should you care?

aisle-business-cart-1005638.jpg

Inflation, we were told today, fell to 2.1% in December - that’s down .2% on the 2.3% figure for November. That’s the lowest inflation rate for nearly two years. According to the Office for National Statistics, the fall was due to cheaper petrol as the world oil price has come down.

An ONS boffin added: "Air fares also helped push down the rate, with seasonal prices rising less than they did last year. These were partially offset by small rises in hotel prices and mobile phone chargers.”

So far so dull. Let’s see why people care about a .2% fall and why you should be interested…

What is inflation?

Inflation is simply the increase in prices across the economy. It’s usually expressed as an annual figure, i.e. the amount that prices have risen over the preceding 12 months. So today the figure was for December 2017-December 2018.

So a Freddo chocolate bar used to cost 10p (the 1994 launch price). It now costs 25p. That is inflation.

How is it measured?

The ONS uses a basket of goods and services that it believes represent the spending patterns of the average UK household. It monitors the prices of this basket from one month to the next in order to come up with a figure for how much prices are increasing across the economy.

Using this basket the ONS calculates a variety of indexes and measures of inflation, but the only one you really need to worry about is the Consumer Prices Index. This is the official measure monitored by the Bank of England (among others).

Is inflation good or bad?

Economists are generally agreed that high inflation is a problem for the economy. It means households and businesses can’t make ordered financial decisions and if inflation escalates it can lead to the complete malfunctioning of a country’s economy.

For individuals like you and I, the obvious downside of inflation is that it eats away at our spending power and our savings. Unless our wages go up at at least the same rate as prices then our income in terms of what it can buy is falling.

Likewise if our savings are not earning a rate of interest at least equal to the rate of inflation, our deposits in the bank are shrinking in real terms.

So surely 0% inflation is what we want?

Not quite. A bit of inflation is seen by economists and governments as representing a healthy economy. If inflation nears 0% and even goes into negative territory (also called deflation) it is evidence of a flatlining economy with low demand and stagnating businesses.

So how much inflation is the right amount?

Well, in the UK the Chancellor of the Exchequer - for the last decade or two at least - has set a target level of 2% for the Bank of England. It’s the job of the policymakers at the Bank, led for the moment by Mark Carney, to try and keep inflation as close to that as possible and certainly within a range between 1 and 3%.

How can anyone influence the rate of inflation?

The Bank of England’s main tool is interest rates, specifically the headline rate which used to be called the Base Rate but is now called the Bank Rate.

This is the rate that is central to all other interest rates used by the banking system.

Increasing interest rates tends to reduce economic activity and therefore dampen down price rises.

Why should I be bothered about inflation?

As we’ve noted, it can make a hole in your pocket. By keeping an eye on the headline rate of inflation, you will know how much your income is losing in spending power and what your savings or investments need to earn just to stand still.

The good news is wages excluding bonuses were up by 3.3% in the three months to October 2018, according to the most recent available figures. 

This means inflation is being outstripped by average UK pay growth. Obviously your individual circumstances may be different.

What about interest rates?

Andy Verity, economics correspondent at the BBC, says: “What’s striking about the inflation figures isn’t so much what they tell you about the cost of living. It’s what they suggest about interest rates… now the betting is a rate rise won’t happen before November.”

In other words, high or increasing inflation makes rate rises more likely in the near future and vice versa. As inflation is now very close to the 2% target, the Bank of England has no incentive to hike the bank rate especially with so much economic and political uncertainty around.

Anything else we should know about inflation?

Yes. The rate of inflation in certain months is used by the UK government to determine various things like how much the state pension should increase the following year, how much train fares are allowed to go up by, and the rate of interest charged by the Student Loans Company.

Is there a topic you’d like to see covered on MoneyLens.com? Or do you have feedback or a suggestion for our jargon-buster? Email contact@moneylens.com or join the conversation on social media.

Read more: What can I invest in? Funds for beginners

Read more: Want to start investing into an Isa? These are the three questions you need to ask yourself

Read more: Shares vs property: where do I invest?

11 investing questions everyone should ask (and answer)

11 investing questions everyone should ask (and answer)

14 of the best money podcasts

14 of the best money podcasts

logo_footer.png