The Consumer Prices Index (CPI)

Consumer Prices Index (CPI) annual inflation fell to 1.6 per cent in August, down from 1.8 per cent in July.  This is still below the Government’s 2 per cent target.

CPI is used by the Government to measure inflation. It does not include council tax or mortgage interest costs. The concern is that CPI could fall further in the coming months.

The Office for National Statistics (ONS) said that lower food costs contributed to the fall in CPI, with the price of fruit, vegetables, bread and meat all decreasing.

If the CPI falls below 1% then the Bank of England governor will have to write a letter of explanation to the Chancellor Alistair Darling.

Retail Prices Index (RPI)

Figures published today by the Office for National Statistics also reveal that annual inflation measured by the Retail Prices Index (RPI) - which includes housing costs such as mortgage interest payments and council tax rose to -1.3 per cent in August, compared with -1.4 per cent in July.

RPI is used to negotiate wage increases, pensions, state benefits and index linked guilts.
Either one of these inflation measures can have a major influence on the economy as they will affect interest rate decisions, pensions and wage settlements.

The Bank of England aims to maintain inflation at 2% to keep both prices and the broader economy stable, however some economists are worried that RPI may eventually move deeper into deflationary territory.

What is deflation?

Deflation occurs when prices are declining over time. This is the opposite of inflation; when the inflation rate (by some measure) is negative, the economy is in a deflationary period.

The worry is that consumers will keep putting off the purchasing goods, because of deflation, in the hope that the item will drop in price even further.