What is the UK Inflation Report? A Must-Read for Traders!

What is the UK Inflation Report? A Must-Read for Traders!

Reading time: 7 minutes

You will recall that inflation has risen on a global scale in recent years, thrusting the cost of living to new heights for many consumers. US inflation topped at 9.1% in mid-2022, closely followed by euro area inflation at 10.6% and UK inflation at 11.1%. With global economies in a disinflation process in 2024 (prices rising but at a slower rate) and central banks poised to begin easing policy (interest rate cuts), there has never been a better time to understand how the UK inflation report works.

Inflation Defined

According to the Bank of England (BoE), inflation is defined as the following:

[…] a measure of how much the prices of goods (such as food or televisions) and services (such as haircuts or train tickets) have gone up over time.

Why are inflation figures one of the most broadly followed macroeconomic statistics? 

Should inflation increase, this can make it difficult for businesses to set prices and plan. Equally, rising prices can make it challenging for consumers to plan their spending, and, especially in the event of elevated inflation, it may cause an erosion of real income for many in society. 

To help the government plan and control inflationary pressures, the government sets an inflation target for the Monetary Policy Committee (MPC) of the BoE, which is currently 2.0% (a common inflation target for many G10 central banks). What many may not know is that should inflation exceed or come in below the government’s set inflation target, the BoE Governor (currently Andrew Bailey) must publish a public letter that defines the reasoning behind the deviation in inflation and what actions the Governor plans to take to remedy the variation. This is freely available on the BoE’s website. 

How is the UK Inflation Report Structured?

Inflation in the UK is largely measured by what is referred to as consumer price indices (or CPIs), structured to track the price change of a large fixed basket of goods and services that are frequently purchased by consumers. The contents of this basket and the expenditure weights assigned to the items are updated annually to reflect changes in spending patterns. To help identify household spending patterns to select goods and services to add to (remove from) the CPI basket, the Office for National Statistics (ONS) uses two main sources of information: household final consumption expenditure (HHFCE) and the Living Costs and Food Survey (LCF). As per the ONS, a representative sample of more than 700 goods and services and approximately 20,000 establishments are regularly monitored for price changes (about 180,000 price quotations).

The ONS distributes the CPIs each month, looking at year-on-year and month-on-month changes. What can be confusing is there is not one set Index used; there are three main indexes released: the Consumer Prices Index including owner occupiers’ housing costs (CPIH), the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). Of relevance, the vast majority of the items in all three baskets are the same. Also important to note is that the CPI is the measure that is employed for the government’s inflation targeting and, therefore, tends to garner the majority of the attention in the financial markets (headline inflation [nominal] and underlying inflation [core inflation, which strips out volatile price components such as excluding energy prices, food, alcohol and tobacco] CPI measures are widely watched).

The main groups of goods and services contributing to the CPI, as shown by the ONS data below, consist of eleven main divisions, including food and non-alcoholic beverages (the largest downward contributions came from food and non-alcoholic beverages between January and February 2024), alcohol and tobacco, transport, and so on. 

The CPIH is the newest of the three indexes, launched in 2013, while the CPI was first distributed in 1996 (note that up until 2003, the CPI was called the Harmonised Index of Consumer Prices [HICP]) and the RPI, the oldest of the three indexes, has a history dating as far back as 1947. The CPIH offers the broadest coverage of goods and services inflation and is the ‘lead inflation index’ for the ONS, widening the CPI measure to account for the ownership and maintenance of living in one’s own home (there is also a separate Index for this, known as the Owner Occupiers’ Housing Costs [OOH]). The RPI is the least followed but continues to be released each month, as, according to the ONS, ‘its subcomponents continue to be published as they are tied to long-term contracts’.

How is Inflation Data Calculated?

The index calculation for both the CPIH and the CPI is constructed by using a Laspeyres Price Index, which can also be referred to as a base-year quantity-weighted method.

The numerator represents the summed total of expenditures for the current period, with the denominator being the summed total of all expenditures as of the base period. We then multiply the resulting value by 100 to produce a percentage increase or decrease. 

What is the Current UK Inflation Rate?

According to the latest ONS report (for February 2024), CPIH inflation slowed to 3.8% in the twelve months to February, down from January’s reading of 4.2%. The CPI, which, as noted above, gathers most of the market’s attention, witnessed year-on-year consumer prices cool to 3.4% in February from 4.0% in January, and month-on-month CPI rose 0.6% in February from -0.6 % in January. Underlying inflation (core) eased to 4.5% on a year-on-year basis for February, down from 5.1% in January, whilst the month-on-month rate increased to 0.6% in February from -0.9% in January. The chart below (provided by the ONS) shows that UK CPIH and CPI inflation are clearly on a downward trajectory.