Page last updated at 20:12 GMT, Tuesday, 24 March 2009

Surprise hike in consumer prices

Fruit and veg at a French market
Food: Especially imported fruit and vegetables, mineral water, meat
Games, toys, hobbies
Petrol, diesel
Mortgage payments
Coffee, tea, cocoa
Gas and electricity bills
Pre-recorded DVDs
Source: ONS

The rising price of imported goods - particularly fruit, vegetables and toys - has caused an unexpected rise in one measure of UK inflation.

The Consumer Prices Index (CPI) was pushed up to an annual rate of 3.2% in February, from 3% a month earlier.

But a sharp fall in mortgage repayments caused the Retail Prices Index (RPI), which includes housing costs, to fall to zero for the first time in 49 years.

Economists had predicted that both measures of inflation would fall.

Hetal Mehta, senior economic advisor to the Ernst & Young Item Club, said: "It is surprising to see CPI inflation increasing when a sharp fall was widely expected."

As well as the weaker pound, which was one factor behind the rising cost of some imported goods, Rob Pike from the Office for National Statistics remarked that December's cut in VAT from 17.5% to 15%, was being reversed.

A substantial number of shops which passed on the VAT cut in December seemed to have changed that by February, he told BBC News.

"We have seen many prices return to the previous selling price in November, or even gone beyond that. And that is quite widespread."

A poor harvest in Spain had led to much higher courgette and cucumber prices, he added.


The Bank of England uses the CPI, the index of consumer prices, as its target when setting interest rates.

A retired couple sit by the sea
Those on a state pension or benefits had 2009-10 payments based on RPI in September which was 5%. They win.
Graduates who took out student loans before 1998 pay interest that tracks RPI. They are likely to win.
Those who do not own their own home but spend their money on food and petrol. They lose.

The increase in CPI has obliged Bank of England governor Mervyn King to write to Chancellor Alistair Darling, to explain why inflation is more than one percentage point above the government's 2% target.

In his letter, Mr King said that despite the increase in the CPI measure last month, "we believe that the sharp decline in CPI inflation since its peak in September is likely to resume in the coming months", with energy prices tipped to fall further.

"It is likely over the next year CPI inflation will move below target, although the profile of inflation could be volatile," he added.

Speaking to Parliament's Treasury committee on Tuesday, Mervyn King said exchange rate depreciation was bound to have a significant impact on price levels and would continue to do so in the coming months.

Deflation risks

The fall in RPI, as recorded in the latest Office for National Statistics data, stems largely from the fall in mortgage repayments after a series of interest rate cuts.

The government uses the broader measure of RPI, the index of retail prices, to set the level of state pensions, welfare benefits and index-linked government bonds. This is set once a year, based on September's inflation figure.

Graph showing contributors to RPI index

While analysts had expected the RPI to fall further to below zero, it was still the weakest reading since 1960.

"The big picture remains that deflation is on its way," according to Vicky Redwood of Capital Economics.

"After all, at zero in February, the RPI measure was as close to deflation as you can get.

"Falling utility and food price inflation should still push CPI into negative territory before long.

There are concerns that if prices keep falling, the UK could suffer a bout of deflation.

A prolonged period of deflation is damaging to the economy as consumers put off spending in anticipation that prices will fall further, hitting retailers and manufacturers.

'Pay depression'

For workers, the latest fall in RPI has implications for wages.

Inflation rates a 'big surprise'

According to John Philpott, chief economist at the Chartered Institute of Personnel and Development: "For millions of workers, this will be a spring and summer of pay depression, as pay rises give way to widespread pay freezes or pay cuts.

"For the vast majority of workers, accustomed as most of us are to an annual boost to our pay packets, a pay freeze or pay cut will feel like a hardship, especially while the CPI measure of inflation continues to rise."

It could also be negative for pensioners. The basic state pension increases by either RPI or 2.5%, whichever is higher.

However, retired people typically spend a higher proportion of their income on food and fuel, which has risen.

And for welfare benefits, which are also linked to RPI, the Department for Work and Pensions said no decision had been made.

A spokesperson for the DWP said "we can't reduce benefits.

"Even though we traditionally up-rate them in line with RPI, we don't have to do this. If RPI is negative we can use discretion."

Liberal Democrat Treasury spokesman Vince Cable said the latest figures painted a "a very contradictory picture" and that it was very difficult to manage policy in such an environment.

Shadow chancellor George Osborne said the latest trend created a tension which "just adds to the economic uncertainty at the moment".

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