CPI Inflation: Well below target
The reversal in the headline consumer price index (CPI) figures to 1.6 per cent in July from 1.9 per cent in June shows inflation remains comfortably below target. But even these headline figures are likely to exaggerate any underlying position, in the sense of a measure that more accurately reflects inflationary pressures from market-based forces of supply and demand that are more relevant for monetary policy purposes. The discussion looks at the latest figures, and derives such a measure by removing the inflationary pressures that follow largely from government policies.
The table below shows figures disaggregated to what the ONS call ‘divisions’, for the latest month, the same month a year ago and the change. Plainly, the significant movements are downward; note too the emergence of three negative figures in July 2014 (the first time three divisions have been in negative territory since 2009).
|Percentage change over 12 months||July 2013||July 2014||difference|
|CPI (overall index)||2.8||1.6||-1.2|
|01 Food and non-alcoholic beverages||3.9||-0.4||-4.3|
|02 Alcoholic beverages and tobacco||6.3||3.6||-2.7|
|03 Clothing and footwear||2.5||-0.2||-2.7|
|04 Housing, water, electricity, gas and other fuels||4.3||3.2||-1.1|
|05 Furniture, household equipment and maintenance||0.1||1.1||1.0|
|09 Recreation and culture||0.7||1.5||0.8|
|11 Restaurants and hotels||2.5||2.8||0.3|
|12 Miscellaneous goods and services||1.5||-0.6||-2.1|
Moreover, the divisions with above-target inflation are mainly those that are heavily influenced by ‘administered and regulated prices’ (using the Bank of England’s previous categorisation). In particular, alcoholic beverages and tobacco are heavily influenced by duties; housing, water etc by the government’s regulatory approach to utilities; and education by student fees.
It is not a straightforward matter to remove items from the CPI, because of the way they are linked and weighted together. However ONS provide some bespoke aggregates in their detailed and very helpful reference tables. The chart below compares a number of ‘excluding’ measures with the headline CPI.
The excluding measures are comfortably below CPI, averaging 1.5 per cent over recent months. But the overall effect on CPI is cumulative, and can be approximated by the contributions of the key administered and regulated at more detailed ‘class’ level. (Thanks to the ONS for providing these.)
|Alcohol and tobacco||+0.16|
|Water and sewerage||+0.03|
|Electricity, gas etc||+0.23|
At face value, this would leave a CPI excluding administered and regulated prices at 0.9 per cent. Perhaps an upper bound, given the implicit assumption that all of the price changes in these categories follows from administered actions; moreover subtracting out categories may not be the same as building up a CPI excluding these categories.
But the point that any underlying measure of inflation is very low surely stands, whether or not the consequent figure is over one percentage point below target.
In open letters to the Chancellor over 2010 to 2012 when headline inflation outcomes were over a percentage point above target, the Governor of the Bank of England used this type of approach to justify not raising rates. There are already many reasons for exercising restraint, not least the historically low earnings growth. But let’s hope the members of the Monetary Policy Committee are also keeping in mind the underlying approach now inflation is well below target.
PS: A sharp distinction must be drawn between the above discussion of an underlying measure of inflation for monetary policy purposes, and the extent of the cost of living crisis. Obviously households’ costs increase irrespective of whether they are driven by market forces or government action. The ONS publish various measures of inflation (CPI, RPI, RPIJ, CPIH, TPI etc) that help to capture the cost of living. But ever since a recent consultation on the methodology of the Retail Prices Index, there has been some uncertainty about which measure (if any) is the most appropriate for these as opposed to monetary policy purposes. Paul Johnson of the Institute for Fiscal Studies is leading a ‘Review of the Range of Price Statistics’, which will address ‘the arguments for using cost of living or cost of goods concepts’. His findings which will be reported ‘by the end of 2014’ are awaited with interest.