The latest figures from the Office for National Statistics (ONS) showed that inflation was down for the third consecutive month, dropping from 10.5 per cent in the 12 months to December 2022 to 10.1 per cent in January.
Of course, while a fall in inflation sounds like really good news, it is important to note that this decrease in headline inflation does not mean costs are going to get cheaper, as Financial Journalist Paul Lewis tweeted: “This does not mean prices are falling! Just rising slightly less quickly.”
Despite this seeming step in the right direction, the price of food has continued to increase faster than ever, reaching a 45-year high. Overall, food prices were up 16.7 per cent in the year to January while sought after products such as sugar, low-fat milk and olive oil saw as high as 40 per cent in the same period. Food prices have been rising due to supply disruption caused by Russia’s invasion of Ukraine last year, but the olive oil price rise is something different. Prices have jumped recently because many olive trees did not produce their fruit due to summer heatwaves that hit the crops in Spain last year. Not enough rain means not enough olives – and too little supply to meet demand means that prices will rise.
An increase in the prices of tobacco and alcohol has also been a key factor in keeping CPI inflation above 10%
In short, we are not out of the woods yet, although things are heading in the right direction.
How is inflation measured in the UK?
In order to calculate an inflation figure, the ONS tracks the prices of hundreds of everyday items and compiles them into one figure. This combination of all the different items and their prices is referred to as the ‘basket of goods’. The basket is constantly updated and adjusted depending on the economic context, and different weightings within the basket are given to different areas of spending in the economy. For example, sports bras and pet collars were added last year, while doughnuts were removed, reflecting the working from home environment that the Covid-19 pandemic created and a desire for a more positive and healthy life.
Each month the ONS releases a new inflation figure which shows how much the combined prices of items in the ‘basket of goods’ have risen since the same time last year.
Why has inflation fallen and what does this mean?
The figures have come in at slightly lower than was widely anticipated. Aside from the obvious factors like the decrease in cost of dining out and the continued fall in fuel prices at the petrol pump, some scrutiny has been placed on the ‘basket of goods’ process that the ONS uses to measure inflation in the UK.
The ONS report detailed how some of the weightings in the consumer price ‘basket of goods’ had been adjusted. For example, the weight of services in the basket rose from 43.7 per cent to 46.3 per cent while the weight of goods was down from 56.3 per cent to 53.7 per cent.
With this, part of the drop in headline inflation rates reflect the weighting changes. Since the pandemic, there has been an increase in spending on services and a decrease in spending on goods. With services inflation lower than goods inflation, increasing its weighting in the basket has contributed to bringing down the overall headline inflation and core rates.
Of course, the downside for savers is that the fall in inflation means the Bank of England will have more flexibility to keep the base rate at 4%, rather than increasing it again, which could mean an end to the hikes that we’ve seen to savings rates over the last year.
Raising the base rate is a way for the Bank of England to control inflation by making it more attractive to save and more expensive to borrow. This means people will borrow less and save more, leading them to spend less, so demand for goods falls. But there is a fine line, as the Bank does not want to curb spending too much as that can slow the economy by more than desired, which can lead to recession - a period of economic decline.
With the possibility that we could be heading towards the top of the interest rate hikes, if you haven’t reviewed your savings for a while, now is a good time to do so, to make sure your cash is working as hard as it can.
Understanding how inflation can impact your spending is key to proper financial planning. If you’re worried about inflation perhaps you'd like to explore if there is anything you should be doing to try to mitigate its effects, so why not get in touch. We’re currently offering all those with £100,000 or more in savings, investments or pensions a FREE financial planning review with one of our TPO colleagues, worth £500. You can find out more here.
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