Reflecting sluggish economic activity and weak consumer confidence, Australia’s inflation has been growing very slowly for some years now. But while inflation is already growing below the Reserve Bank’s target range of 2%, the changes made this week to how the Bureau of Statistics calculates the consumer price index means that inflation is most likely lower than previously counted. It means the chances of an interest rate rise are even less likely and pressures for increased wages growth will remain weak.

Inflation, it must be said, is a damn complex thing. You have to try to work out what the average Australian household spends their money on each week and then you have to monitor those purchases by canvassing different stores to ensure you catch sales and price drops as well as changes to items that are the same price but now contain more or less product.

It makes for a confusing picture because not only can you not really provide a figure that represents anyone – unless you know of a household that spends money each week buying a new car or house – it means the numbers are open to abuse.

In the 2013 election for example, the then Liberal party sought to talk about cost of living rises by purporting to give people a “cost of living calculator”. It did this by allowing people to put in how much they spent each month on electricity, gas, water, rents, insurance, medical and education expenses. It then calculated how much your “cost of living” had risen since the ALP had taken power in November 2007.

Not surprisingly the items the Liberal party had picked were the ones that had increased the most. It didn’t include, for example, food even though one would think that would be a significant aspect of your cost of living. Perhaps that had something to do with food prices rising slower during the ALP’s time than overall inflation. Similarly the calculator didn’t include the price of clothes and footwear, or audiovisual equipment, even though the price of those actually fell during the Rudd-Gillard years.

And that is the problem with inflation and cost of living – we mostly focus on the price rises and forget or discount the falls. Political parties know this, which is why you will never hear a politician talk about cost of living other than to say how they are constantly rising and that people are under pressure.

Indeed, the Liberal party is unlikely to put out the same cost of living calculator at its next election. While rents and water prices have risen slower than overall inflation, all of the other items in the 2013 calculator have outpaced the CPI – and since the election last year electricity prices have zoomed ahead:

And where things get really complex is that this might suggest that inflation is growing too fast. The Reserve Bank has a target for inflation growth of between 2% and 3% and yet in the past three years only one quarter has seen the CPI within that band:

This is actually not a good sign. We’re not spending, and thus prices are not rising, and thus our wages are not rising and thus we’re not spending ... and on and on it goes.

But the reality is that even though inflation is now very low, the CPI figures have most likely been overstating inflation.

This is because of the way the consumer price index is calculated.

The ABS estimates the average amount spent by all households on various items because they need to weight the items – clearly the price of rents going up matters more than the price of eggs.

But as prices go up or down, our spending habits change. We try to take advantage of things that are cheaper and we try to avoid things where the prices rise – and yet the CPI does not take that into account.

It is for this reason that Westpac argues that with the re-weighting of the CPI this week, annual inflation growth is up to 0.35% lower than it now is being recorded.

The problem is that the last weighting of the CPI was six years ago – which means the CPI figures assume we were spending money on things in September this year the same as we were in September 2011.

This means that the importance of items that rise in price is often overstated.

Take tobacco, for example. In 2011 the ABS estimated that on average households spent 2.3% of their weekly spending on cigarettes and the like – clearly if you are a smoker you spend more than that, but the average takes into account non-smokers as well to get an average of all households.

But since then the price of tobacco has risen 93% – easily the biggest price rise of any times. And yet during that period the CPI figures have assumed that the same proportion of Australians has been smoking the same amount as they did in 2011 – ie that no one has either quit or cut down.

This has meant that the contribution tobacco has on overall inflation has risen. In September it contributed 4% to the total CPI.

The new weighting is 2.63% – which means the impact of tobacco on inflation will drop significantly.

This might sound counterintuitive because the new weighting for tobacco is up from 2.3% in 2011. But the reason that it has risen is because the price has gone up but people are smoking less. If people were still smoking the same amount as in 2011 the new weighting would be 4%:

The new weightings thus reflect not only changes due to price rises but also our changes in our spending habits. The new weighting for rents, for example, reflects not only that the price of rents has increased but also that more people are now renting than six years ago – which is why rents will now contribute more to inflation than it previously did:

If we look at the 15 items whose price rose and fell the most in the past year, the contribution of the price rises on inflation are being overestimated quite significantly, whereas the contribution of the price falls are only being slightly underestimated:

It all means that inflation is probably lower than the ABS has been saying. Westpac estimates the impact such that it has lowered its forecast for inflation growth next year from 2.35% to 2.0%.

It also means the chances of an interest rate rise are diminishing quickly.

In September, the market thought a rate rise was certain to occur by August next year. Two weeks ago that had been pushed out to December, and now the market is “certain” it will occur by February 2019:

The problem for the government is that the price of many of the big necessities such as electricity and gas and health costs are rising fast, but overall inflation remains extremely low. That low outlook will continue to feed into wage negotiations and ongoing low wage growth, and it suggests that we will be stuck in this new normal of low inflation growth for some time to come.