First the good news: inflation, according to the consumer price index (CPI), dropped to an annual rate of 2.4% in July, down from 2.5% the previous month. The bad news, however, is that virtually nobody believes that the cost of living is increasing that slowly.
After all, domestic electricity costs were up 25.9% year-on-year, and gas bills rose even more sharply; the annual pace of 37.1% is the steepest since 1963. Food prices ticked up sharply in July, petrol prices have risen and council tax bills have been climbing faster than inflation.
According to the insurer Clerical Medical, inflation for pensioners, who are especially hard-hit by dearer energy bills, has reached a ten-year high of 3.9%.
And Professor Richard Scase of the University of Kent reckons that, for the average middle-class family, inflation is running at 10%.
The trouble is the CPI excludes or inadequately reflects items that are becoming more expensive. Edmund Conway in The Daily Telegraph notes that, since 2003, the amount we spend on gas and electricity is up 64% and 45% respectively, according to official statistics.
Yet as far as the CPI is concerned, the respective figures are 17% and 7%. It is also underweight in services and transport and over-emphasises imports that have been getting cheaper, such as clothes and electronic goods, says George Trefgarne in the same paper. And it omits housing costs and tax, which is why it has “barely budged” as house prices have soared and Gordon Brown has pushed through 60 tax hikes over the past nine years.
If you live on benefits, “scoff processed food and play computer games, inflation has indeed been non-existent in the past few years”. Perhaps the CPI should stand for “Chav Price Index”.
All this isn’t just a theoretical debate, as David Prosser notes in The Independent. The CPI determines the Bank of England’s interest-rate policy, so the Bank could end up making a wrong move if presented with a misleading picture.
There’s also the question of inflation expectations, says Robert Cole in The Times. If people think the true rate of inflation is markedly higher than the official number, they are more likely to demand higher pay, which could trigger a wage-price spiral.
So far, while inflation has ticked up in recent months – Bank of England governor Mervyn King has warned it could exceed 3%
by the end of the year – there has been scant sign of “second-round effects” in the form of a wage-price spiral. However, that could now
change, as we noted in our daily investment email MoneyMorning last week.
Average earnings were up 4.3% on an annual basis in July, up from 4.1% in June. The wealth effect from rising house prices is dissipating, so many workers may bite the bullet and ask their boss for a pay rise, while it remains to be seen how public-sector workers – the most militant part of
the workforce – will react to Gordon Brown’s attempt to wean them off
the inflation-busting salary hikes of recent years.