The Consumer Prices Index (CPI) - measure used by Bank of England to set interest rates

Consumer Prices Index (CPI) annual inflation climbed to 3.5% in January, the fastest annual pace for 14 months, up from 2.9% the month before according to the Office for National Statistics (ONS), which is well above the target of 2 per cent set by the Government.

Rising fuel costs have helped towards the rise of CPI, along with VAT returning to its normal 17.5%.

CPI is used by the Government to measure inflation. It does not include council tax or mortgage interest costs.

Retail Prices Index (RPI) - measure used as a benchmark in wage negotiations

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 3.7% up from 2.4% on the month before.

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 letters

Following the announcement that CPI inflation in the 12 months to January was 3.5 per cent, the Bank has published a letter from the Governor to the Chancellor, as required by the monetary policy remit. A copy of the letter is available below. The Chancellor’s reply to the Governor is also available below.

Letter from the Governor to the Chancellor 15 February 2010 PDF (123K)

Letter from the Chancellor to the Governor 16 February 2010 PDF (823K)

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.

ONS has a personal inflation calculator on its website as a guide for the public to measure their own inflation.

Full report can be found at: statistics.gov.uk

Debtwizard comment

Petrol prices which are behind this inflation increase are starting to become a worry for many consumers, a year ago it was around 86p per litre now it is around 1.12. This huge increase will reduce the amount of spending power consumers have and they can do nothing about it as many need petrol just to get to work. Oil producers are notoriously slow in passing on reduced production costs so I can see no hope yet on any reduction in the price of petrol.

Another problem has been the VAT rate with it reverting back to its original amount of 17.5%, this in turn will make goods more expensive and will fuel inflation throughout this year.

I am no economist but I remember every time I have watched the news I am told that one way of fighting higher inflation is to increase interest rates, so this may well happen unless the government gets this under control, and quickly.

Higher interest rates will have an impact on those that rely on borrowing, such as mortgages and credit card debts as they will become over time more expensive to service.

Meanwhile savers will welcome any increase as they feel they have been punished for putting money aside and for being prudent with their finances. The 11 month run on historic low interest rates have eroded their savings and drastically reduced any income that they relied on upon to supplement their day to day living.