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How does UK inflation work? ONS process for calculating cost of living through CPI and RPI explained

The UK’s cost of living crisis has worsened as a result of rocketing food and fuel price inflation, with worse still to come according to the Bank of England

The cost of living crisis engulfing the UK has continued to worsen, with the latest figures from the Office for National Statistics Consumer Price Index (CPI) showing inflation sat at a new 40-year high of 9.1% in May.

Household budgets are struggling with steep rises to food prices and record fuel costs, while energy bills look increasingly likely to rocket again later in 2022.

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So how are inflation statistics calculated - and what exactly does high inflation mean?

Here’s what you need to know.

The current CPI rate of 5.5% means the cost of everything from food to transport is rising (image: AFP/Getty Images)

What is inflation?

Inflation is an economics term for a sustained increase in prices that simultaneously sees purchasing power decrease.

These price hikes are driven by many different factors, like the price of oil, supply chain disruption or the scarcity of a particular product - i.e. whatever affects the cost of getting products from where they are produced to the consumer.

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For example, the cost of margarine and vegetable fats rocketed on the CPI by 26% year-on-year in May 2022.

This hike came largely as a result of Russia’s invasion of Ukraine, with both countries being key suppliers for these types of product.

This conflict has dented existing supplies of sunflower oil and rapeseed oil - two vegetable fats that are key ingredients in many food products, including crisps and mayonnaise.

It could also decimate future supplies, as there are major doubts whether Ukrainian growers will be able to plant their crops this year.

The average shopping trolley has gone up in price 3.4% according to Which? data (image: AFP/Getty Images)

Sharp rises in inflation, like the one seen for the vegetable fats category, can severely impact the cost of living and see consumers opt to reduce their spend on more luxury goods and services to focus on life’s necessities.

Overall, this is bad news for the economy.

But gradual inflation is seen by some economists as a good thing.

They believe it encourages shoppers to spend rather than run the risk of seeing the value of their money decrease.

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The thinking is that this contributes towards a healthy economy, where people spend their cash and create more demand for goods and services by doing so, which maintains supply chains and employment.

If there was deflation, it is believed consumers would not feel the need to spend as much right away because their purchasing power could extend further in the future.

How is inflation calculated?

The UK has two mechanisms for calculating inflation which are worked out by official statistics body the ONS every month.

This data not only allows people to make informed decisions about their spending habits but it is also used to set state handouts, like pensions, benefits and statutory sick pay.

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CPI

The most important measure of inflation in the UK, and internationally, is the CPI.

Used as the UK’s official inflation yardstick, it’s worked out by measuring the price of a typical ‘basket’ of goods and services we use in our everyday lives.

This basket includes everything from the price of a loaf of bread to how much a cinema ticket costs and is determined by the annual Family Expenditure Survey, which is completed by 6,000 people and determines the percentage of people’s incomes that are spent on different things.

It changes every year, with items added or taken away to better reflect current shopping habits.

Every year, the ONS measures inflation using a typical ‘basket’ of goods and services the average household spends money on (image: Adobe)

For example, in 2022, meat-free sausages, sports bras and antibacterial surface wipes have been added, while men’s suits and doughnuts have been removed.

The ONS weights each product or service category depending on its importance to the average Brit’s budget.

It means things that are integral to our lives, like food, have more of a bearing on the CPI rate than luxuries, such as alcohol.

In all, the ONS gathers 180,000 individual prices for more than 720 consumer goods and services every single month.

Inflation rates allow us to make informed choices about what we spend our money on (image: Getty Images)

These prices are collected in roughly 140 locations across the UK, as well as from the internet and over the phone.

Percentage increases in price are then multiplied by the weighting the particular product category has been given, which gives us a picture of how much of an impact it is having on consumer budgets.

The ONS also calculates a version of the CPI that includes home owner occupier costs and council tax (CPIH).

While it is a more comprehensive measure of overall inflation, it masks day-to-day consumer price changes because housing is given a huge weighting.

It also makes it harder to make international comparisons, as the UK’s housing system is very different from those in other countries.

RPI

Alongside the CPI, the ONS also calculates inflation through the Retail Price Index (RPI).

However, it is not used for official purposes as, by international standards, it is seen as an inferior measurement to the CPI.

The reason why it is still calculated is because it provides a historical yardstick for how UK inflation has changed.

This is because it was used for much of the twentieth century.

RPI is still used to determine some UK prices, for example train tickets and mobile phone bills.

What does the current CPI mean?

The CPI rate rose to 9.1% in May 2022 - up 0.1% from the 9% figure recorded in April and 2.1% higher than March.

What this means is that the ‘basket’ of goods and services cost 9.1% more than it did back in May 2021.

It compares to a rate of 2.1% that was recorded in May 2021 when the UK was beginning to emerge from its last national Covid lockdown.

The UK’s official statisticians say the current CPI is the highest it’s been since inflation began to be calculated this way in 1989.

Historic modelling from when inflation was officially calculated through the RPI shows the previous high came in March 1982.

Inflation is expected to continue to rise as a result of further energy, food and fuel price hikes, most of which are being driven by the global impacts of the Russia-Ukraine conflict.

The Bank of England has predicted it could peak at 11% later in 2022.

Ultimately, it means your money will not stretch as far as it would have done 12 months ago.

This budget squeeze is particularly acute in housing costs (including electricity bills), which are tracking 19.4% above May 2021, transport (costs are 13.8% higher) and furniture and DIY (10.8% higher).