UPDATE: Listen to Pete Comley talk about the latest inflation data on Share Radio:
The latest data appears to show a decline of UK inflation back to near-zero levels. CPI fell from 0.5% to 0.3% in April 2016. However, as ever, the headlines do not tell the full story.
Inflation has been very gradually picking up since autumn 2015. March showed a sharp rise, and arguably ahead of the trend. However as we pointed out last month, that rise was largely spurious and related to two aspects of inflation that are quite volatile because of the way that the ONS measure them, i.e. airfares and clothing.
ONS look at airfares on just one day in the month so the timing of holidays, such as Easter, has a profound effect on the monthly stats. That is why it appears that airfares have fallen sharply in April and not because of any fundamental reduction in Ryanair’s pricing. Clothing inflation is also based on specific items that can often significantly vary in pricing due to sales and the effects of substitutions, as new lines become available.
Inflation primarily remains low because the combined effects the decline in import commodity prices (especially oil) and competition amongst food retailers. Indeed the Bank of England pointed out last week that the impact of lower energy prices have not been fully reflected in CPI, as it only monitors variable rate gas tariffs and not the fixed rate contracts which most gas companies have reduced the most. Therefore it might be argued that inflation is closer to zero than CPI currently shows.
RPI more truly reflects real inflation
However there are many issues with the way CPI is calculated that actually result in it probably under-estimating inflation. Far from experiencing no inflation, many people (especially younger ones) are experiencing inflation that is not reflected in the CPI numbers. The average consumer thinks inflation is currently running at 1.7% (Barclays Basix data in BoE report).
A better estimate of inflation is thus provided by the 1.3% RPI. It does not involve clever statistical wizardry called geometric means which will always lower reported inflation by up to 1%. RPI also includes the impact of house prices. According to ONS stats today, house prices are up 9%. Curiously even RPI does not include this full impact and is assuming just 6.8%, so even RPI may be underestimating inflation.
Outlook for inflation
Next month, and longer term, inflation is likely to continue to slowly head back up from here, no matter which measure is used. Assuming crude oil prices stabilise around $50, the steep decline in oil price in the second half of 2015 will be falling out of the calculation this autumn. There is also beginning to be clear evidence of food price war having cut prices to about as low as they are going to get – there were very few new lows for key basket items this month – just chicken and white sliced loaves. Furthermore, service inflation is running at 2.4%. Prices rose sharply last month for cultural events and restaurant/hotel prices have picked up too – possibly the impact of the minimum wage rises.
The full ONS report can be found here.