The squeeze on British household budgets showed signs of easing in December as the rate of inflation fell for the first time in six months, helped by lower airfare costs and a fall in the price of games and toys.
The consumer price index fell to 3% last month from a five-year high of 3.1% in November, raising the prospect that inflation may have peaked, easing some of the pressure on UK consumers. Economists had expected the rate to moderate as the effects from the fall in sterling since the Brexit vote – which pushed up the cost of importing food and fuel – begin to wash out of the system.
Inflation is when prices rise. Deflation is the opposite – price decreases over time – but inflation is far more common.
If inflation is 10%, then a £50 pair of shoes will cost £55 in a year's time and £60.50 a year after that.
Inflation eats away at the value of wages and savings – if you earn 10% on your savings but inflation is 10%, the real rate of interest on your pot is actually 0%.
A relatively new phenomenon, inflation has become a real worry for governments since the 1960s.
As a rule of thumb, times of high inflation are good for borrowers and bad for investors.
Mortgages are a good example of how borrowing can be advantageous – annual inflation of 10% over seven years halves the real value of a mortgage.
On the other hand, pensioners, who depend on a fixed income, watch the value of their assets erode.
The government's preferred measure of inflation, and the one the Bank of England takes into account when setting interest rates, is the consumer price index (CPI).
The retail prices index (RPI) is often used in wage negotiations.
The Office for National Statistics said the slowing rate of growth was offset partially by higher tobacco prices, reflecting the duty increases that came into effect following the budget, as well as a rise in petrol and diesel prices.
Inflation remains at its highest level since April 2012, having risen relatively steadily since the EU referendum, when the consumer prices index (CPI) was at 0.5%. The squeeze on living standards has proved a key political flashpoint, used by the Labour party as evidence of the Conservatives’ economic failure.
Peter Dowd, Labour’s shadow chief secretary to the Treasury, said the inflation figures were “further bad news for working households”, adding that real pay is still lower now than it was in 2010. The Treasury said it was “helping families with their everyday costs of living” by cutting tax bills, freezing fuel and alcohol duties, and raising the minimum wage.
December’s fall in inflation will be closely watched by the Bank of England, which has previously said it expected the CPI to peak in the final months of 2017 before falling back to about 2.4% at the end of this year. That would be above its 2% target rate, which it said was justification for raising interest rates even as inflation fades.
However, statisticians at the ONS said it could be too early to tell if the drop last month was the start of any longer-term reduction in the rate of inflation. British households are also still coming under pressure from weak wage growth, which stood at 2.3% in the three months to October, and could remain below the rate of inflation this year.
Although the Bank may still look to raise interest rates from 0.5%, pushing the cost of borrowing to levels unseen since before the financial crisis, economists said there were still difficult patches ahead for the economy, which may be unsettled by the Brexit negotiations.
Suren Thiru, the head of economics at the British Chambers of Commerce, said the best option was therefore “a prolonged period of monetary stability, to keep interest rates steady over the near term”.
Although the CPI fell last month, the alternative retail prices index measure of inflation, which includes mortgage interest payments and house prices, rose to 4.1% last month from 3.9% in November, reflecting the higher cost of borrowing after the Bank raised interest rates for the first time in a decade.
The ONS said house prices in the UK increased by 5.1% during the year to the end of November, with the average value of a home going up by £11,000 over the course of the year to stand at £226,000. The most expensive place to live in the country was Kensington and Chelsea, where the average cost of a home was £1.3m, while the cheapest was Burnley, where an average house cost £79,000.
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