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Inflation still exceeds growth and interest rates as pound drops

HDR long exposure in the middle of Piccadilly Circus on a busy weekend afternoon in front of the Eros statue.

Despite a recent drop in CPI inflation, living standards stay squeezed as interest rates and economic growth remain low

The Office for National Statistics (ONS) has published figures showing CPI (consumer price index) fell to 2.3% in March 2018, down from 2.5% in February. This drop, to the lowest level of CPI inflation since March 2017, marks a 12- month rate of 2.5%. However, the other gauge used to measure price increases, the retail price index, or (RPI), was almost a third higher at 3.6%.

“Inflation fell to its lowest rate in a year, with women’s clothing prices rising slower than usual for this time of year,” said Mike Hardie, head of inflation at the ONS. The slowing of inflation, which has risen considerably since the Brexit vote in June 2016, has been largely seen as good news as, for the first time in almost a year, wages grew ahead of CPI.

“Wage growth has now outstripped inflation for two months in a row. This could herald the beginning of a real improvement in living standards, which will be a boost for hard-pressed families. With the UK unemployment rate at a new record low, it’s clear that the labour market remains a key strength for the UK economy,” said the Confederation of British Industry’s head of Economic Intelligence, Anna Leach.

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Inflation (blue), is still above economic growth (red) and interest rates (black)

Despite this outlook, inflation has continued to outstrip economic growth and wage growth for several years, impacting living standards across the UK. The UK economy is predicted to grow by just 1.6% this year, down from 1.8% last year. Interest rates remain at just 0.5%, and although a rate rise by the Bank of England is widely predicted for next month, inflation will continue to erode the value of the pound.

Conversely, the value of the pound on the currency markets fell, having risen over the last few days. The pound lost 0.54%, losing almost a cent against the dollar.

The pound dropped against the dollar

The pound dropped against the dollar

House price inflation remains above 4%, falling to 4.4% from 4.7%, while private rent prices rose in the year to March 2018 by 1.1%

What’s the difference between RPI and CPI?

Both RPI and CPI are measures of inflation, RPI stands for retail price index and CPI for consumer price index. The essential difference is in how they are calculated. RPI takes a simple average, or arithmetic mean, by adding up the price of certain items and then dividing by the number of those items.

CPI uses a geometric mean to identify the factor by which prices have increased. This involves multiplying the numbers, rather than adding them up, and then finding the ‘nth root’. If it is just two numbers this would be the square root, if it is three number it is the cube root and so on.

The advantage of this method is that the mean is not distorted by the large numerical increases. However, it is therefore typically lower than the mean used in RPI, which reflects how much more people are likely to be spending overall, rather than per product.

The difference between the two is very useful for governments, who like to peg pay rises to CPI, currently 2.3%, and taxes to RPI, currently 3.6%.