"Inflation" seems to be the buzzword in financial circles and the tabloid press. But what does that mean for your family, and most importantly, your shopping basket?
Inflation refers to the price increase that's taking place on the things UK consumers most frequently buy. Confusingly, it's measured in two different ways: the Consumer Price Index (CPI) and the Retail Price Index (RPI). The two measures use different formulae in their calculations, but the main differences are that RPI accounts for increased mortgage and council tax, while CPI does not. CPI also factors in people's switch to lower-priced products during a price squeeze. In general, CPI will be lower than RPI.
How inflation works
The rule is that, as RPI or CPI rise, your shopping costs increase. As they go down, your shopping costs decrease. Of course, if your earnings increase in line with inflation, the ‘real cost' stays the same because as prices rise, so do your wages. It's when wages and inflation are out of sync that you'll really feel the weight of inflation in your shopping basket.
It's debatable, but not unreasonable, that RPI gives the best indication of how your shopping basket is changing. It tells you how much, on average, prices have gone up (or down), and the average impact that higher mortgage and council tax costs will have on your spending power. After all, that's what we need to know before we decide to switch to cheaper items or services.
The Bank of England sees things differently, though, and determines interest rates based on CPI. So if you're more concerned with how your savings and mortgages will change in the future, keep an eye on that.
How it affects your shopping
RPI inflation shows us how much shopping costs have increased in the past generally the last year. But to see just how much your shopping bill is changing, it's important to show the cumulative affect over several years. An informative piece of maths in The Telegraph shows just how serious it can be by looking back at the cost of Second Class stamps, which have jumped from 24p in 2007 to 50p in 2012.
The other thing to note is that these inflation measures are an average, taken across large numbers of products. The only way you can compare the changes in the products you buy to inflation is by closely monitoring your own finances. When making close calculations like these, you'll need a clear view of your financial history and spending, and tools like Money Dashboard's free money manager software do just that.
After inputting your account details into our secure, read-only software, you can see your historical spending broken down by category, and even calculate the percentage increase (or decrease) in your shopping basket spend. You can also monitor the change in your mortgage outgoings, giving you a better idea of the impact of inflation across your financial life.
Posted by Marc Murphy, Marketing Manager at Money Dashboard.