In the opening section of Article 16 I explain the various measures of inflation used in the UK. It might be useful to illustrate the main two definitions with reference to the latest inflation data which was published today. The headlines will be dominated by the Retail Price Index (RPI) which fell to 0% in February on an annual basis compared to 0.1% in January. This is a wide measure of inflation that includes housing costs. The sharp fall in mortgage rates in the last year has driven this measure of inflation to the lowest level in nearly 50 years. However, the annual rate did not turn negative as many commentators had predicted.
The Government's preferred measure is the Consumer Prices Index (CPI) and this actually rose unexpectedly from 3% to 3.2%. As a result the Bank of England's head Mervyn King will have to write again to the Chancellor (Alistair Darling) explaining why inflation is more than one percentage point above the government's own 2% target.
Against this background the FT-SE 100 index has fallen back slightly this morning which is not that surprising as we have seen a strong rebound in the UK equity market in the last few days.
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4 comments:
Hi Kevin!
Thank you for the interesting article. Can you explain how does the increase of CPI influence further actions of the UK government? Do companies use this information?
Thank you.
Natalia Kalitenko
Thanks for your excellent comment.
The Government has set a target level of 2% for the annual rate of CPI. The Bank of England must ensure that this is met. So as the CPI is currently above target it will be harder to justify further cuts in interest rates or a fiscal stimulus. This might explain the comments from the Bank of England's Governor yesterday.
Also companies do use the CPI. For example, it might play a role in setting the level of wage increases.
Thanks again
Kevin
Hi Kevin,
When we talk about government's inflaion rate target, are we talking about the RPI or CPI? From the article it looks like it is the CPI.
Even in the current state of the economy, the CPI is above the target. It looks like the bank is in a difficult position then as it has to reduce CPI and increase RPI. So what can the Bank do to achieve these?
I would use this opportunity to ask another question which is not directly related to this article. What effect could quantitative easing have on the value of sterling? Could we say that because of the increase in money supply sterling's value would fall?
Thanks for the comment Mohamed...
Here are the answers to your questions:
1) The Governnment sets a target for CPI not RPI. You should read page 111 to see more about the target.
2) There is a problem at least in the short-term. As you say the RPI is too low while CPI is too high! Most economists expect the CPI rate to fall back sharply in coming months as the Worldwide slowdown results in lower prices of commodities and labour (wages). However, in the latest data there were surprising increases in a range of items including food.
3) In terms of quantitative easing you are 100% correct. We would anticipate tha this would result in a fall in the value of the money following on directly from the increase in money supply.
An excellent set of questions! Thanks
Kevin
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