Inflation and CPI

Inflation is the rate at which prices rise. In the UK it is measured by the Office for National Statistics (ONS), which tracks the prices of a large basket of goods and services every month. The headline figure compares prices with the same month a year earlier.

The measures you'll hear about

• CPI, the Consumer Prices Index: the measure behind the Bank of England's 2% target
• CPIH: CPI plus the costs of living in your own home and council tax, which the ONS treats as its lead measure
• RPI, the Retail Prices Index: an older measure the ONS doesn't recommend, still used in some contracts, index-linked gilts and many student loan interest rates
• Core inflation: CPI without energy, food, alcohol and tobacco, whose prices swing a lot
• Services inflation: price rises for things like haircuts, insurance and restaurant meals, which is closely tied to wage growth

Core and services inflation get a lot of attention because they show how much inflation is coming from inside the economy, rather than from global energy or food prices that a central bank can do little about.

Reading a release

Inflation is the percentage change in a price index, not the change in its points. An index that started at 100 makes the two look the same, but most indices have long since moved away from 100.

Falling inflation doesn't mean falling prices. If inflation drops from 4% to 2%, prices are still rising, just more slowly. Prices only fall on average when inflation turns negative, which is called deflation.

Watch for base effects. Because the headline rate compares with a year ago, a big price jump twelve months earlier drops out of the calculation and can pull inflation down sharply, even if prices rose by a normal amount in the latest month.

Real and nominal

Nominal figures are in today's pounds. Real figures strip out inflation to show what money can actually buy. Pay, returns and economic growth are all worth comparing in real terms.

Why finance cares

• Inflation drives interest rate decisions, which move gilt yields, sterling and share prices
• Bond investors lose out when inflation rises unexpectedly, because fixed coupons buy less
• Companies with pricing power can pass rising costs on, while others see margins squeezed
• Wage negotiations, pensions and some benefits are linked to inflation figures