Week 20, 2011: Inflation

Summary: UK inflation figures for April came out this week, showing that prices had risen by 4.5% compared to this time last year (a 0.5% increase on the figure in March). This will give the Bank of England Monetary Policy Committee a further headache when they have to decide what to do with interest rates.

What does the chart show? The chart shows the Consumer Prices Index (CPI) broken down into various categories. The CPI is the official measure of inflation, and the chart above shows the percentage change in the price level when compared to the same month a year before. The black line shows the overall CPI - the headline figure that everyone talks about. The dotted grey line shows what is called the CPI(Y); that is, the CPI excluding indirect taxes. This is helpful because it strips away the effect of the increases in VAT and duties on alcohol and tobacco, for example, and show the underlying price changes. The coloured lines show how some of the components of the CPI have moved individually - red is alcohol and tobacco, blue is transport, green is housing costs and related services (such as water, electricity and gas bills), and gold is clothing and footwear.

Why is the chart interesting? Inflation continues to rise, and it won't be long before the Bank of England have to try to do something about it (by raising interest rates). 4.5% is the highest the CPI has been since October 2008, although once you exclude indirect taxes, the figure is only 3%. Having said that, prices in the real world mostly include indirect taxes, and the danger is that people come to expect high inflation and begin to demand higher wages, which feeds into higher inflation rates, and so on.

The headline figure hides what is actually causing inflation, which is why it is interesting to look at some of the components. Transport prices are one of the main factors behind the rise in inflation, and have been for a long time. This essentially comes down to the high price of oil (which also affects the "housing and related services" category through more expensive utility bills). The prices of alcohol and tobacco goods are also rising quickly; this is presumably down to tax increases. On the other hand, clothing and footwear has not been rising in price very much, although it may feel like it after a long period of falling prices.

The real trouble facing those trying to deal with inflation is that the two main factors behind it - oil prices and taxation - are not within their control.