What is inflation and how is it calculated? September figures unchanged from August

Big jumps in the cost of petrol and diesel in September meant the rate of inflation was unchanged since August despite food and non-alcoholic drinks getting cheaper (PA Wire)
Big jumps in the cost of petrol and diesel in September meant the rate of inflation was unchanged since August despite food and non-alcoholic drinks getting cheaper (PA Wire)

The UK inflation rate for September was 6.7%, according to ONS figures released this week, making it the same as August.

Although the annual inflation rate has fallen considerably over the past three months, the latest figures revealed the downward trajectory has stalled, contrary to what financial experts expected.

This has been a blow for Rishi Sunak, who has consistently tried to lower the country’s inflation rate so it returns to official targets. Officials suggested the figure shouldn’t prompt concern and that inflation rates don’t always fall in a straight line.

Jeremy Hunt, the Chancellor of the Exchequer, said: “As we have seen across other G7 countries, inflation rarely falls in a straight line, but if we stick to our plan then we still expect it to keep falling this year.

"Today’s news just shows this is even more important so we can ease the pressure on families and businesses.”

According to ONS economists, the price of food and non-alcoholic drinks fell by 0.2 per cent over the month and price rises for a number of household items eased. However, increases in the cost of fuel and hotel stays stopped the inflation rate from falling below August's rate.

While some prices are rising slower than others, many consumers remain concerned about supermarket bills.

But what is inflation and what does it mean for wages and mortgages?

What is inflation?

Inflation is a measure of the rate at which the prices of goods and services increase. It can occur when prices rise due to increases in production costs, such as raw materials and wages.

For example, if a bottle of milk costs £1 and that rises by 5p compared with a year earlier, then milk inflation is five per cent.

A surge in demand for products and services can cause inflation, as consumers are willing to pay more for the product.

What causes inflation?

There are various factors that can drive up prices or inflation in an economy. Typically, inflation results from an increase in production costs or in demand for products and services.

In the short term, high inflation can also be the result of people having a lot of surplus cash, or accessing a lot of credit and wanting to spend.

Despite consumers receiving little to no benefit from inflation, investors can profit if they hold assets in markets affected by it. For example, those who have invested in energy companies might see a rise in their stock prices if energy prices are rising.

How is inflation calculated?

Inflation is calculated by measuring changes in the cost of living, and the official method used is the CPI. It is worked out by measuring the price of a basket of goods and services we use every day. This basket includes everything from eggs to e-books, and is regularly updated.

It is determined by the annual Family Expenditure Survey, a voluntary survey of about 6,000 people conducted by the ONS. It helps to determine the percentage of people’s incomes that are spent on different things.

Once the survey results are in, the Government checks the prices of the 1,000 most common goods in the UK every month. The percentage changes in the price of individual goods and services are noted.

Percentage increases in price are then multiplied by the weighting the particular product category has been given, which shows how much it is affecting consumer budgets.

How does inflation work?

Inflation occurs when prices rise across the economy, decreasing the purchasing power of money. It refers to the broad increase in prices across a sector or industry, and ultimately a country’s entire economy.

Inflation can become a destructive force in an economy if it is allowed to get out of hand and rise dramatically.

Unchecked inflation can topple a country’s economy, as it did in 2018 when Venezuela’s inflation rate hit more than 1,000,000 per cent a month. This caused the economy to collapse and forced countless citizens to flee the country.

What does inflation mean for mortgages?

Rising inflation will have an impact on homeowners but how much depends on the terms of their mortgage.

The Bank of England may increase interest rates to try to slow inflation when it rises.

As a result, when interest rates rise, mortgages can become more expensive, although this will depend on their type.

People who have tracker mortgages, which track a base rate (usually the Bank of England’s), will see their interest rates rise a month after the Bank of England increases the base rate.

Meanwhile, people on fixed-rate mortgages won’t be affected immediately. These mortgages fix the interest rate a homeowner will pay for a certain length of time – usually two years or five years.

Once a tracker or fixed mortgage comes to an end, lenders can put borrowers on a standard variable rate mortgage. This means mortgage payments could change each month, depending on the rate.

What does inflation mean for wages?

When inflation rises – and when wages don’t keep up – it affects the real value of pay. This means that wages don’t stretch as far as they used to.

Over the last few months, percentage increases in prices have been at their lowest since February 2022, meaning that most people were better off for the first time since October 2021. However, the latest announcement has bucked the trend.