What is inflation, as it remains steady at 4%

What is inflation, as it remains steady at 4%

UK inflation stayed at four per cent in January, according to the Office for National Statistics (ONS).

Despite many analysts expecting inflation to be higher than it was in December, the unexpected development will raise hopes of interest rate cuts this year. They had predicted a January rate of 4.2 per cent.

According to the ONS chief economist, January’s steady inflation rate was linked to the counteracting effects of goods and services prices.

“Inflation was unchanged in January reflecting counteracting effects within the basket of goods and services,” Grant Fitzner said. “The price of gas and electricity rose at a higher rate than this time last year due to the increase in the energy price cap, while the cost of secondhand cars went up for the first time since May.

“Offsetting these, prices of furniture and household goods decreased by more than a year ago and food prices fell on the month for the first time in over two years.”

Despite government efforts to bring inflation down, it actually increased for the first time in 10 months before January, going up by 0.4 per cent between November and December, as a result of the higher cost of living and an increase in tobacco duty.  So this week's news will garner relief that inflation hasn’t risen again.

The chancellor, Jeremy Hunt, said: “Inflation never falls in a perfect straight line but the plan is working; we have made huge progress in bringing inflation down from 11 per cent and the Bank of England forecast that it will fall to around two per cent in a matter of months.”

The rise and fall of inflation has various implications for UK consumers and can affect their purchasing power and savings.

But what is inflation, and what does it mean for wages and mortgages?

What is inflation?

Inflation is a measure of the rate at which the prices of goods and services increase. It can occur when prices rise due to increases in production costs, such as raw materials and wages.

For example, if a bottle of milk costs £1 and that rises by 5p compared with a year earlier, then milk inflation is five per cent.

A surge in demand for products and services can cause inflation, as consumers are willing to pay more for the product.

What causes inflation?

There are various factors that can drive up prices or inflation in an economy. Typically, inflation results from an increase in production costs, or in demand for products and services.

In the short-term, high inflation can also be the result of people having a lot of surplus cash, or accessing a lot of credit and wanting to spend.

Despite consumers receiving little to no benefit from inflation, investors can profit if they hold assets in markets affected by it. For example, those who have invested in energy companies might see a rise in their stock prices if energy prices are rising.

How is inflation calculated?

Inflation is calculated by measuring changes in the cost of living, and the official method used is the CPI. It is worked out by measuring the price of a basket of goods and services we use every day. This basket includes everything from eggs to e-books, and is regularly updated.

It is determined by the annual Family Expenditure Survey, a voluntary survey of about 6,000 people conducted by the ONS. It helps to determine the percentage of people’s incomes that are spent on different things.

Once the survey results are in, the Government checks the prices of the 1,000 most common goods in the UK every month. The percentage changes in the price of individual goods and services are noted.

Percentage increases in price are then multiplied by the weighting the particular product category has been given, which shows how much it is affecting consumer budgets.

How does inflation work?

Inflation occurs when prices rise across the economy, decreasing the purchasing power of money. It refers to the broad increase in prices across a sector or industry, and ultimately a country’s entire economy.

Inflation can become a destructive force in an economy if it is allowed to get out of hand and rise dramatically.

Unchecked inflation can topple a country’s economy, as it did in 2018 when Venezuela’s inflation rate hit more than 1,000,000 per cent a month. This caused the economy to collapse and forced countless citizens to flee the country.

What does inflation mean for mortgages?

Rising inflation will have an impact on homeowners but how much depends on the terms of their mortgage.

The Bank of England may increase interest rates to try to slow inflation when it rises.

As a result, when interest rates rise, mortgages can become more expensive, although this will depend on their type.

People who have tracker mortgages, which track a base rate (usually the Bank of England’s), will see their interest rates rise a month after the Bank of England increases the base rate.

Meanwhile, people on fixed-rate mortgages won’t be affected immediately. These mortgages fix the interest rate a homeowner will pay for a certain length of time – usually two years or five years.

Once a tracker or fixed mortgage comes to an end, lenders can put borrowers on a standard-variable rate mortgage. This means mortgage payments could change each month, depending on the rate.

What does inflation mean for wages?

When inflation rises – and when wages don’t keep up – it affects the real value of pay.

This means that wages don’t stretch as far as they used to, and employees have less purchasing power.