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Largest ever increase in UK inflation

CPI annual inflation which is targeted by the government, rose to 2.9% in December 2009 from 1.9% in November. This increase of 1.0% was the largest ever increase in the annual rate between two months.


Why was the increase so large, especially considering that the consensus amongst City economists was for a rise to 2.6%? The basic reason is not so much about what happened this year but what happened last year. We have to remember that we are looking at an increase based on the figures for the previous year, and what happened to prices in December 2008 was exceptional.


There were three main contributing reasons. Firstly, the standard rate of VAT was cut from 17.5% to 15.0% in December 2008. Secondly, there were sharp falls in the price of oil and thirdly, there were, unusually, pre-Christmas sales that month as a result of the economic downturn. Taken together, these events led to the CPI falling by 0.4% between November and December 2008. This means that the increase of 0.6% in the CPI between November and December 2009, together with the previous year’s fall, generated the 1.0% upturn in the index. In fact, a monthly increase of 0.6% in the CPI between two months is not in itself so untypical.


The recent trend can be seen in the graphic below.

Source: ONS

Source: ONS


The largest upward pressure on the CPI in December 2009 was from the transport sector, with fuels and lubricants rising in price by 0.2% on the month, compared with a fall of 6.2% a year ago. There was also upward pressure from clothing and footwear where prices fell between November and December 2009 but fell less than they between the same two months in 2008. However, overall, there was upward pressure on prices from 10 of the 12 divisions which the ONS measures and there were no significant downward pressures.


As far as RPI annual inflation is concerned this rose by 2.1% from 0.3% in November to 2.4% in December 2009. The last time there was a monthly increase of this magnitude was between June and July 1979. The RPI was affected by the same pressures as the CPI as shown above. But, in addition, it was affected by the housing sector. Here, mortgage interest rates which fell significantly between these months in 2008 actually rose in the same period of 2009.


RPIX inflation, which is the RPI excluding mortgage interest payments rose from 2.7% in November to 3.8% in December 2009. At the same time, core inflation, which excludes food, energy, tobacco and alcohol rose by 2.8% on an annualised basis, which again is the fastest growth rate since records began in January 1997.


What of the future? The Bank of England has forecast that the CPI will show a rise of about 2.6% over the first quarter of 2010 and once the change back up in the VAT rate has worked its way through, many economists believe the CPI will fall back. There is also a difference of opinion as to the length of the time lag for the previous falls in the value of sterling to work their way through into higher domestic prices, and if these have been underestimated, we may see more pressure on the CPI in the months ahead.


Finally, disposable incomes increased by 5.2% in the year to the third quarter of 2009, particularly due to the effect of lower mortgage payments. If this goes into spending rather than the running down of existing debt as has been happening, then again we could see a feed through into higher prices.

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Posted in Consumer Expenditure, Consumer Price Index, Inflation

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