Inflation makes a surprise upward move

Lots of people are expressing their surprise at the rise in inflation to 2.7% (from 2.2% last month).  I'm not sure we really should be that surprised or that worried.

Inflation is the CONTINUOUS RISE in the general price level, reducing the purchasing power of real incomes. This rise is due to three main factors:

1. A rise in university tuition fees.
2. A rise in food prices due to the poor weather
3. A rise in energy bills

The Bank of England is supposed to keep inflation at 2%, but are allowed a 1% margin before they have to apologise. Should they really be concerned with this rise?

Well 2.2% was a 34 month low for inflation and so things seemed to be coming back under control, so this will be a blow to the men from Threadneedle Street. But the first two factors that caused inflation must be seen as 'one-off' influences. Tuition fees will not rise as much next year (from £3k to £9k this year) and it is unlikely that the awful weather of this year will be repeated next year.

So both the first two influences will drop out of the index next year. As for energy bills this market is known to be volatile and so there is little that can really be read into the price rise in terms of future inflation.

Also inflation is really concerning when it affects everybody. Tuition fees affect only a small proportion of the population, but the current massive rise makes the index jump significantly despite the small weight it is given in the basket.

So the Bank of England will almost certainly carry on looking at underlying inflation when setting interest rates and not the headline figure. Overall demand remains weak and while there are encouraging signs of recovery it is unlikely that interest rates will rise until well into next year even so.

The Daily Telegraph has a good explanation of inflation trends here

Inflation falls, but not for long?

The CPI and RPI fell by 0.3% last month. That is good news for the MPC and keeping to the inflation target and is the lowest rate on CPI since November 2009.

The cause of the fall in inflation illustrates that the figure is a moving average. A year ago gas and electricity prices rose significantly, but this year they did not. Of course there were other price rises but not as much as a year ago.

The importance of the September inflation figure is that it many benefits are increased in line with it. So its important for next years Government spending and the fall in inflation is good news for George Osborne.

The BBC covers the story and shows both the influences on the current inflation rate and reviews the benefits that are affected. There is also a section on why lower inflation is good for some people and firms.

The BBC story is here

From market prices to inflation

Markets set the prices for individual goods. Inflation is the continuous rise in the general price level. Of course we are taught that we must not confuse the two. When the price of a particular good rises this is due to either a rise in demand or a supply constraint, not inflation. But surely there is a connection?

The issue of food prices is a good example of where we can link market prices and inflation. Food prices generally are about to rise due to several factors:

1. The wet summer in the UK has led to a lower harvest and it is proving difficult to plant next years crop.
2. There have been droughts in the USA, Russia and southern Europe during the growing season.

This means that cereal prices overall are rising. It's due to a supply shock, relative scarcity has increased.

But this is going to feed through into inflation as it will cause a wider impact on prices.

Clearly the goods which use soya, wheat etc will have to pass on the extra costs. The price of bread for example. But cereal crops are also used to make biofuel and to feed animals. So we can, at the very least, expect the price of meat to rise too.

While these are changes in relative prices of individual goods this will feed through into inflation. Food is a significant item in average household budgets and so has a significant weight in the CPI. The rise in food prices, and goods which use inputs from the agricultural sector, will feed into CPI and cause a rise in the index.

This is, of course, quite reasonable. Average households will find the cost of living is rising

The Guardian covers the story here