Wanna Argument?
The Bank's reaction to inflation
In March 2007, UK inflation rose to over 3%, its highest rate since 1992. This was sufficiently above the target rate for the Governor of the Bank of England to take action. But he didn't resign, or raise interest rates; he took out his pen and wrote a letter. This is the deal that the Chancellor of the Exchequer struck over monetary policy in 1997.
The Chancellor sets the target rate for inflation and decides how it will be measured. Currently, he uses the Consumer Price Index (CPI) to gauge the inflation rate. CPI inflation must be within 1% (plus or minus) of its target level, which is 2%. If not, then the Governor has to write an open letter to the Chancellor explaining why and outlining the action to be taken.
So when inflation was reported at 3.1% for March, Mervyn King, Governor of the Bank of England, wrote to Gordon Brown, Chancellor of the Exchequer, to say why. Brown accepted the reasons and expressed satisfaction with King's assurance that inflation would fall back to within its target in the near future.
Measuring inflation
Have you noticed your weekly shop becoming more expensive? This could be down to inflation - or maybe you just bought more stuff! Copyright: Biz/ed team.
That's the background, but it's important to provide more detail about rising prices. The answer to the question about whether or not prices are rising fast in the UK is that some are and some aren't. We need to understand a little about inflation measurement in order to make sense of this.
Inflation is measured by tracking changes in the price of a 'basket' of goods and services in the UK. The 'basket' consists of a range of items, thought to represent average consumption in the country. Some goods and services leave the 'basket' over time, to be replaced by others according to tastes, fashion and technological change (among other reasons). So, for example, DVDs are now included in the basket, whereas ten years ago their place may have been taken by video cassettes.
Movements in the price of the total basket of goods and services are recorded on a monthly basis. The difference between the total price now and a year ago is calculated. It is this figure, expressed as a percentage rise (or fall), which is the reported rate of inflation.
So, a 3% rise in inflation doesn't mean that the price of all goods and services have risen by that extent. Some will have gone up in price by more and some less than 3%. Inflation may seem to be higher to many people than the reported figure for a good reason: the price of necessities has risen more rapidly in the past year than the price of items bought only once in a while.
The goods and services that have been most responsible for the acceleration in CPI inflation are energy prices and food. Those that have risen more slowly in price include furniture and cars. People take more notice of price changes of items bought more frequently than they do of goods and services consumed less often.
So the answer to the original question is that, yes, CPI inflation has risen to its highest level for a number of years. But it is people's inflationary expectations, fuelled by media coverage, which have made price rises seem more pronounced than they actually are. Whatever the reason, the Bank of England's Monetary Policy Committee (MPC) is expected to raise the base rate of interest to 5.5% at its next monthly meeting (May 2007).