Sonia Speedy, Tuesday July 15, 2008
With inflation at a 10-year high of 3.8%, there is no doubt that a bigger chunk of our incomes is disappearing on the basics. But just how hard are we being hit and how do we best measure these price increases? We reveal the real effect of inflation.
The rate of inflation has today hit a record high of 3.8% - the highest level reached since the current measure was introduced back in 1997. Yet the real rate of price rises could be significantly higher - one recent newspaper headline claimed that the cost of living has increased by 11.5% over the last year, suggesting Britain is facing the most savage inflation for a generation.
The reality is that many costs are indeed soaring. Gas and electricity bills are up 15% on average this year, while the latest figures from independent supermarket comparison site Mysupermarket.co.uk suggest that staple food prices are also up 15% on the same time last year. Meanwhile, petrol prices have recently hit a 20-year high.
Concern about these rising costs has led 500,000 public sector workers to embark on two days of strike action tomorrow as they fight for pay rises that keep pace with the 'real' cost of inflation, rather than the Government's measure.
How can you work out how much your cost of living is increasing? We take a look.
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Measuring 'real' inflation
There are currently two main ways that inflation is measured in the UK - the Government's
preferred CPI and what is known as the Retail Prices Index (RPI). The Government has set itself the
target of keeping inflation at 2%, but it's currently running at 2.5%. The RPI. on the other hand,
is at 3.8%.
Both of these measures work by tracking the prices of a selected basket of goods and services. But, there are two basic differences.
They differ in terms of exactly what goes into those baskets of goods and services and are also based on different underlying assumptions. The RPI also reflects housing costs, such as house prices and mortgage interest costs, while the CPI does not.
"The result of those two differences, in ordinary circumstances, is that CPI inflation is normally about three quarters of a per cent lower than the RPI," says Jonathan Loynes, chief UK economist at independent research consultancy Capital Economics.
Loynes believes suspicions that the CPI dramatically understates inflation are "overdone" and consumers simply notice price hikes more than they notice the price decreases. He also suggests that it is "not impossible" that RPI inflation could fall below the CPI in the next six to 12 months if cuts in interest rates continue.
Meanwhile, Moneysupermarket.com's Louise Cuming suggests that because it includes housing costs, the RPI is a more "realistic" measure of inflation for homeowners. However, for those who are unlikely to have a mortgage like pensioners, Cuming believes that the CPI is more applicable.
