Interpreting the inflation figures: guidance on how to analyse the changes in annual inflation rates

Transcription

1 Interpreting the inflation figures: guidance on how to analyse the changes in annual inflation rates Jim O Donoghue Office for National Statistics jim.o donoghue@ons.gov.uk Introduction Each month the ONS publishes the Consumer Price Indices First Release and accompanying detailed Briefing Notes. These two documents contain a wide variety of information about the Consumer Prices Index (CPI), which forms the basis for the government s inflation target, and the long-established Retail Prices Index (RPI) whose uses include indexation of pensions and state benefits. The information published includes the detailed components of the two main indices; derivative indices based on them; and commentary describing the factors contributing to changes in the overall inflation rate (the percentage change over 12 months) when compared with the previous month. This article provides guidance on how to use this information and how to interpret the detailed tables and charts published in the CPI First Release. It focuses in particular on how contributions to the inflation rate are calculated and can be used. This is illustrated by looking at the CPI figures for a particular month, with the tables and charts presented being based on those published in the CPI First Release for September Headline inflation rates The government s inflation target that the Bank of England s Monetary Policy Committee is required to achieve is based on the CPI (prior to 10 December 2003 it had been based on the RPI excluding mortgage interest payments, known as RPIX). The target is currently set at 2 per cent. Figure 1 shows the CPI inflation rate between January 1997 and September It ranges from a low of 0.5 per cent in May 2000 to highs of 2.5 per cent in September 2005, June 2006 and August In the period since the CPI was adopted as the target measure and September 2006, the CPI annual inflation rate ranged between 1.1 per cent and 2.5 per cent. Figure 1 also shows the inflation rates for RPI and RPIX. The RPI inflation rate is considerably more variable than the CPI s, ranging between 0.7 per cent and 4.2 per cent over the period shown, in large part reflecting the inclusion of mortgage interest payments (MIPs) in the RPI - as can be seen, RPIX (RPI excluding MIPs) has moved in a much narrower range.

2 4.5 Figure 1: CPI, RPI and RPIX: Percentage change over 12 months RPI Per cent RPIX CPI Jan 1998 Jan 1999 Jan 2000 Jan 2001 Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan RPI and CPI derivatives A number of derivative indices, based on the two headline figures, are published each month. These derivative indices are intended to provide an insight into underlying inflationary pressures either by stripping out volatile elements, such as seasonal food or petrol, or by removing those elements which are influenced by Government-driven tax changes, such as alcohol and tobacco. The derivative indices which receive most attention are: RPIX formerly the government s inflation target RPIY the RPI excluding MIPs, council tax and indirect taxes and duties. This index shows how underlying prices are changing at a time when prices might be influenced by Government-driven tax changes CPIY the CPI excluding indirect taxes and duties. This index is the CPI equivalent of RPIY CPI-CT the CPI calculated with indirect taxes and duties held constant at those rates prevailing in the base period. The difference between CPI-CT and CPI inflation rates shows the effect of government changes in indirect taxation. CPI excluding energy, food, alcoholic beverages and tobacco commonly called the core measure of inflation by economic analysts. These indices appear in Table 1 of the First Release, except for the last listed which appears in Table 5. More information on each of these indices can be found in the CPI Technical Manual ( The rest of this article focuses on the CPI but the description of how to analyse and interpret the figures applies equally to the RPI.

3 Beneath the headline figures The CPI covers the full range of consumer purchases made by households in the UK (excluding most owner-occupier housing costs) and it is instructive to examine how prices are changing below the headline level. The goods and services covered by the CPI are classified according to the internationally agreed Classification of Individual Consumption by Purpose (COICOP). Table 1 (which relates to Table 4 in the First Release) shows the inflation rates for the 12 main COICOP divisions. Most divisions show consistently increasing prices, with strong growth in the most recent periods for housing, water, electricity, gas and other fuels. It can also be seen that a few divisions, most noticeably clothing and footwear, and, over the last 3 years, recreation and culture, have seen persistently declining prices. Figure 2 shows the variation in inflation rates by division in September Figure 2: CPI Divisions: September 2006: annual rate Food & non-alcoholic beverages Alcohol & tobacco Clothing & footwear Housing & household services Furniture & household goods Health Transport Communication Recreation & culture Education Restaurants & hotels Miscellaneous goods & services All items 2.4% Percentage change over 12 months Table 2 (which relates to Tables 2 and 3 in the First Release) shows the full COICOP breakdown. COICOP is a hierarchical classification comprising at the most detailed level classes (e.g meat); groups (e.g food); and divisions (e.g. 01 food and non-alcoholic beverages). The table helps explain some of the results seen at division level. For instance, it shows that the high annual rate for housing and household services has been driven in large part by strong growth in the cost of electricity, gas and other fuels, which were increasing at an annual rate of 30 per cent in September At the other end of the scale, prices of audio-visual equipment and related products were falling by in excess of 10 per cent per year, with prices for data processing equipment (such as laptops and personal computers) falling by over 20 per cent per year. It is also interesting to see how inflation rates vary for goods and services separately. Most of the divisions in the COICOP classification contain a mixture of goods and services. Table 3 (which relates to Table 5 in the First Release) groups the COICOP classes into a goods and services breakdown. This provides a different perspective on

4 the figures. It shows that the inflation rate for goods is much lower than that for services (see also Figure 3). Most categories within non-energy industrial goods are falling in price. By contrast, most services prices are rising. Figure 3: CPI Goods and services: annual rates of change 6 Percentage change over 12 months Services Goods Jan 1998 Jan 1999 Jan 2000 Jan 2001 Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan Contributions to the CPI inflation rate The preceding discussion focused on comparisons of the inflation rate for different categories of expenditure. It is possible to take this further by looking at the contribution of different categories to the overall CPI inflation rate. The size of a contribution is a function of both the weight of the component (its share of overall household expenditure) and its annual rate of change. For instance, a component with a weight of 4 per cent and an inflation rate of 5 per cent will be contributing roughly 0.2 percentage points (4 per cent x 5 per cent) to the overall inflation rate. (The actual calculation is more complicated than this because weights change annually. Annex 1 shows the formulae actually used.) The sum of the contributions across all component categories equals the overall inflation rate for the CPI. Table 4 shows trends in the contributions to the CPI inflation rate for the main COICOP divisions over the period since the start of As might be expected given their positive inflation rates, most divisions have positive contributions. The largest positive contribution in September 2006 came from housing and household services (see Figure 4). Meanwhile clothing and footwear and recreation and culture have negative contributions, reflecting their negative inflation rates. By comparing the contribution of particular components at different points in time it is also possible to look at the factors contributing to changes in the overall inflation rate between those months (see Table 5).

5 Figure 4: CPI Divisions: Contribution to the CPI annual rate: September 2006 Food & non-alcoholic beverages Alcohol & tobacco Clothing & footw ear Housing & household services Furniture & household goods Health Transport Communication Recreation & culture Education Restaurants & hotels Miscellaneous goods & services Percentage points Figure 5 shows the contributions to the change in the CPI inflation rate between August and September 2006 for the main COICOP divisions. There are both positive contributions and negative contributions, reflecting the changes in the annual rates of the individual components. For instance, the annual rate for furniture and household goods increased from -0.5 per cent in August to +0.3 per cent in September. This resulted in an increase in the contribution of this component from percentage points to percentage points, with a contribution to the change in the overall CPI annual rate of (+0.02%)-(-0.06%) = +0.07%. These figures are summarised in Table 6 along with the corresponding figures for transport which had a downward contribution to the change in the annual rate of percentage points, reflecting a fall in the annual inflation rate for this highly weighted component from 2.4 per cent to 0.6 per cent. Figure 5: CPI Divisions: Contribution to change in CPI annual rate: Sept 2006 Food and non-alcoholic beverages Alcoholic beverages & tobacco Clothing and footwear Housing & household services Furniture & household goods Health Transport Communication Recreation and culture Education Restaurants and hotels M iscellaneous goods and services Percentage points

6 Analysing the percentage change over the latest month The discussion above has focussed on examining the change in the 12-month rate from one month to the next. An alternative way of looking at the data is to look at the percentage change in the index over the latest month and to compare this with the same month in the previous year. This is equivalent to analysing the change in the annual inflation rate (see Box 1) and, because it focuses on what has happened over the most recent time period, is the preferred way of looking at the reason for an upward or downward contribution to the change in the CPI annual inflation rate. Table 6: Contributions and percentage changes for selected CPI divisions: August and September 2006 Furniture and household goods Transport Aug 2006 Sept 2006 Aug 2006 Sept 2006 Weight 2006 (%) Percentage change over 12 months Contribution to 12-month rate (%) Contribution to change in 12 month rate (%) Sept 2005 Sept 2006 Sept 2005 Sept 2006 Percentage change over 1 month Generally, a category will make a positive contribution to the overall change in the CPI annual rate if its 1-month percentage change in the current year is more positive, or less negative, than in the same month in the previous year. The converse is true for downward contributions. Thus in Table 6, the 1-month rate for furniture and household goods in 2006 is greater than in the previous year (+1.5 per cent compared with +0.7 per cent) leading to an upward contribution, whereas transport costs fell by more than a year previously, leading to a downward contribution. Occasionally, changes in weights between the current year and the previous year lead to a contribution to the change in the annual rate which appears to be the opposite to what might be expected from the changes in prices. This is a fairly rare occurrence because weights tend to change relatively slowly between years. It is also possible to look at the contributions to the one-month rate and compare this with the same month in the previous year: this is broadly equivalent to looking at the contributions to the change in the 12-month rate.

7 Box 1: Analysing the contributions to the change in the annual rate Category i will make a positive contribution to the change in the CPI annual rate if its annual rate in month t is greater than in the previous month, algebraically: I I i t i t 12 1 *100 > I I i t 1 i t 13 1 *100 where I i t is the index for division i in month t This formula can easily be rearranged to show that category i will make a positive (or upward) contribution to the change in the CPI annual rate if the percentage change over one month for the current year is greater than the percentage change for the corresponding month in the previous year: I I i t i t 1 1 *100 > I I i t 12 i t 13 1 *100 The converse is also true: category i will generally have a negative (or downward) effect on the change in the CPI annual rate if the percentage change over one month for the current year is less than the percentage change for the corresponding month in the previous year. (These results are generally true but it should be noted that changes in weights between successive years, particularly if relatively large, may complicate this analysis.) Commentary in the CPI First Release and Briefing Notes The following information is included in the CPI First Release and accompanying Briefing Notes for each COICOP category: Index levels, weights and percentage change over 12 months; Percentage changes over 1 month for the current month and the same month in the previous year; Contributions to the change in the annual rate. The commentary in the First Release describes the main upward and downward contributions to the change in the CPI annual rate for the latest month. Comments are generally included for each of the 12 main divisions if they have a contribution of +/ percentage points to the change in the CPI annual rate. Contributions of +/-0.04 percentage points or more are referred to as large ; lesser contributions are referred to as small. Within a division, classes with a contribution to the change in the annual rate of +/-0.02 or more percentage points are identified. Within a class, individual items, or categories of expenditure, with a contribution to the change in the annual rate of +/-0.01 or more percentage points may also be identified. The commentary often mentions what happened to prices in the current year (1-month change) compared with the previous year.

8 A similar approach is adopted in the Briefing Notes, except that all COICOP classes with a contribution of +/-0.01 percentage points to the change in the CPI annual rate are commented on. The commentary in the First Release and Briefing Notes may also explain whether increased prices are the result of higher priced replacement stock (particularly for clothing when the new season s stocks enter the shops), recoveries from special offers, or general price increases. Similarly, falling prices may be the result of lower priced replacement stock, special offers, or general price reductions. It may also be possible to identify which types of shops are contributing most to the change in the annual rate, or to point to media reports of factors influencing prices. An example of the latter might be reports of good or bad weather affecting supplies of particular fruit or vegetables. The overall aim is to provide users with a good understanding of the main factors contributing to the latest month s figures. An extract from the First Release commentary for September 2006, showing how the data in Table 6 for furniture and household goods, and transport costs were described follows: The only large downward effect on the CPI annual rate came from the operation of personal transport equipment, where prices for fuels and lubricants fell this year compared with increases a year ago. The average price of petrol decreased by a record 6.4p per litre between August and September this year, from 97.5p to 91.1p on collection day, but rose by 4.6p last year. The average price of diesel also fell over the same period, compared to a rise a year ago. This was partially offset by transport services, where upward contributions came from: Air fares, where although prices fell by a similar amount to last year, the reduced weight this year led to an upward contribution; and Sea fares, where the seasonal fall in prices in September was less than last year for various sea crossings. The largest upward effect on the CPI annual rate came from furniture, household equipment and routine maintenance, due to: Furniture and furnishings, particularly bedroom furniture and leather settees, where prices continued to recover from the summer sales and rose by a greater amount this year compared with a year ago; and Major appliances and small electrical goods, where prices overall rose this year compared with little change a year ago.

9 Reconciling the differences between the CPI and RPI inflation rates As was seen in Figure 1, the RPI and CPI inflation rates frequently differ. Table 10 of the CPI First Release provides a reconciliation between the RPI and CPI inflation rates, as shown in Table 7. Table 7: Breakdown of the differences between CPI and RPI Difference between Breakdown of differences (unrounded figures) annual rates Housing components excluded from CPI other formula other CPI - RPI total Mortgage Other differences effect differences rounded unrounded interest housing in coverage including payments components of goods & weights services 2006 Jul Aug Sep The reconciliation shows the contributions of the following four elements: Housing components excluded from CPI: this shows by how much the annual rate for the RPI would be different if it did not include some housing elements which are excluded from the CPI, principally mortgage interest payments, council tax and housing depreciation. Within this category, the contributions from mortgage interest payments and the other housing components are shown separately. Other differences in coverage: this shows the effect of other differences between the CPI and RPI in the coverage of goods and services. The CPI includes items such as unit trust and stockbroker charges, overseas students university fees and accommodation costs in university halls of residence, which are excluded from the RPI. For the RPI, the relevant items are vehicle excise duty and trade union subscriptions, which are excluded from the CPI. Formula effect: this shows the effect of using different mathematical formulae to calculate price indices at the most detailed level. The CPI uses the geometric mean as opposed to the arithmetic means used in the RPI. Other differences, including weights: is calculated as the residual, partly reflecting the fact that the other components in the reconciliation are calculated independently and so are not strictly additive. The impact of differences in expenditure weights attached to the various items common to both the CPI and RPI baskets are included within this residual. For a more detailed description of the differences between the CPI and RPI, see Roe and Fenwick, The New Inflation Target: the Statistical Perspective,

10 Annex: Contributions to the annual inflation rate Contribution to the CPI rate of change The contribution of a component to a change in the all items CPI over a given period of time is defined as the change that would have occurred in the all items index if that component had undergone its observed change but all other component indices had remained frozen at their values at the start of the period (and all weights are kept the same). The effect of each component depends on both the size of its change and its weight. The formula for calculating the contribution of a component to the monthly change in the CPI is given below: Contribution of component i to monthly change in all items CPI = i i i I t It-1 wt i a It-1 It The formula for calculating the contributions of components to the all items CPI 12 month rate is as follows. There are three parts to this formula reflecting the fact that the CPI weights change twice a year: in January when the new published class weights come into effect and in February when the unpublished item weights are updated: c c c ( ) c ( ) c ( 100) c c wy 1 I I + wy I 100 A Dec t 12 Jan A 100 I + wy I t I Jan A A A Dec 1000 I 1000 A I Dec t 12 I 1000 t 12 I 100 t 12 where: c = component c A = all items CPI w c y = weight (parts per thousand) of component c in CPI in year y I c t = index for component c in month t based on January of current year = 100 I A Jan = all items index for January based on previous month (December) = 100 I A Dec = all items index for December based on previous January = 100 As the definition of the variables above makes clear, it is important that these calculations are performed using unchained indices (i.e. based on previous January = 100, or for the January index, based on previous December =100). Example calculation Using the formula above, the contribution of food and non-alcoholic beverages to the CPI all items annual rate for September 2006 can be calculated as follows. The published (chained) index values, based on 2005=100, for food and non-alcoholic beverages and the all items CPI are as follows:

11 Published (chained) index (2005=100) Jan 2005 Sep 2005 Dec 2005 Jan 2006 Sep 2006 Food and non-alcoholic beverages All items In order to work out the contribution of food and non-alcoholic beverages to the all items CPI 12-month rate for September 2006, it is necessary to unchain the indices so that they are based on the most recent January or, in the case of the January indices, on the previous December. This is done by dividing the current month s index by the previous January s (or December s) figure. For instance, the food and non-alcoholic beverages index for Dec 2005 (the first link month) is calculated as: I i = 100 = Dec 99.2 Performing this calculation for each of the dates gives the following set of unchained index values. Unchained index Based on Jan 2005 Based on Based on Dec 2005 Jan 2006 Jan 2005 Sep 2005 Dec 2005 Jan 2006 Sep 2006 Food and non-alcoholic beverages All items The contribution of food and non-alcoholic beverages to the 12-month rate for September 2006 can then be calculated as follows, given that the weights for food and non-alcoholic beverages in 2005 and 2006 are 106 and 102 parts per thousand respectively: contribution = 106 ( ) ( ) ( ) = 0.40% Thus food and non-alcoholic beverages contributed 0.40 percentage points to the all items CPI 12-month rate in September Contribution to changes in the RPI The formula for the contribution of components to the monthly change in the RPI is the same as for CPI. However, the formula for the contribution to the change in the annual rate is simpler, reflecting the fact that the RPI has a single chain-link each year, in February when both the section and item weights change. The formula is as follows:

12 Contribution of component i to annual change in all items RPI = i i i ( - i i w I -12 ) ( -100) -12 L I t t w I t t a I a a L 1000 It It-12 where: I = component i a = all items RPI I i = index for component i (base previous January = 100) in month t t I i = index for component i in Link month, i.e. index for current January based L on previous January = 100 w i = weight (parts per 1000) of component i in all items RPI in month t t As with the corresponding formula for the CPI, it is important that when using this formula that the calculations are performed using unchained indices (i.e. base period January =100) indices.

13 Table 1: Consumer Prices Index: annual rate of change by division Percentage change over 12 months Food and nonalcoholic beverages Alcoholic beverages & tobacco Clothing and footwear Housing, water, electricity, gas and other fuels Furniture, household equipment & routine maintenance Health Transport Communi cation Recreation and culture Education Restaurant s and hotels Miscellane ous goods and services CPI (overall index) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Source: National Statistics

14 Table 2: CPI: annual rate of change by division, group and class Percent Apr May Jun Jul Aug Sep All items Food and non alcoholic beverages Food Bread & cereals Meat Fish Milk, cheese & eggs Oils & fats Fruit Vegetables including potatoes and other tubers Sugar, jam, syrups, chocolate and confectionery Food products Non-alcoholic beverages Coffee, tea, cocoa Mineral waters, soft drinks and juices Alcoholic beverages, tobacco Alcoholic beverages Spirits Wine (inc perry) Beer Tobacco Clothing and footwear Clothing Garments Other articles of clothing & clothing accessories Dry-cleaning, repair and hire of clothing Footwear including repairs Housing, water, electricity, gas and other fuels Actual rents for housing Regular maintenance and repair of the dwelling Materials for maintenance and repair Services for maintenance and repair Other services relating to the dwelling Water supply Sewerage collection Electricity, gas and other fuels Electricity Gas Liquid fuels Solid fuels Furniture, household equipment & maintenance Furniture, furnishings and carpets Furniture, furnishings Carpets & other floor coverings Household textiles Household appliances, fittings and repairs Major appliances and small electrical goods Repair of household appliances Glassware, tableware and household utensils Tools and equipment for house and garden Goods and services for routine maintenance Non-durable household goods Domestic services and home care services Health Medical products appliances and equipment Pharmaceutical products Other medical products & therapeutic equipment Out-patient services Medical services and paramedical services Dental services In-patient services Transport Purchase of vehicles

15 New cars Second-hand cars Motor cycles and bicycles Operation of personal transport equipment Spare parts & accessories Fuels & lubricants Maintenance & repairs Other services Transport services Passenger transport by railway Passenger transport by road Passenger transport by air Passenger transport by sea and inland waterway Communication Postal services Telephone & telefax equipment and services Recreation and culture Equipment and accessories including repair Equip. for receiving & reproducing sound & picture Photographic and cine. equ. & optical instruments Data processing equipment Recording media Repair of audio-visual equipment & related products Other major durables for recreation and culture Major durables for in/outdoor recreation Other recreational items, gardens and pets Games toys and hobbies Equipment for sport camping & open-air recreation Garden plants and flowers Pets and related products Recreational and cultural services Recreational and sporting services Cultural services Newspapers books and stationery Books Newspapers and periodicals Misc. printed matter, stationery & drawing material Package holidays Education Hotels and restaurants Catering Restaurants & cafes Canteens Accommodation services Miscellaneous goods and services Personal care Hairdressing & personal grooming establishments Appliances, articles & products for personal care Personal effects n.e.c Jewellery clocks and watches Other personal effects Social protection services Insurance House contents insurance Health insurance Transport insurance Financial services n.e.c Other services n.e.c Source: National Statistics

16 Table 3: Consumer prices index: Detailed goods and services breakdown: annual rate Percentage change over 12 months Apr May Jun Jul Aug Sep CPI (overall index) All goods Food, Alcoholic Beverages & Tobacco Processed Food & Non-Alcoholic Beverages Non-processed Food Seasonal Food Meat Alcoholic Beverages & Tobacco Industrial Goods Energy Electricity, Gas & Misc. Energy Liquid Fuels, Vehicle Fuels & Lubricants Non-Energy Industrial Goods Clothing & Footwear Goods Housing Goods Household goods Water supply; materials for maintenance/repair Medical products, appliances and equipment Vehicles, spare parts and accessories Recreational Goods Audio-Visual Goods Other Recreational Goods Miscellaneous Goods Services Housing Services Actual Rentals for Housing Primary Housing Services Other Housing Services Travel & Transport Services Services for Personal Transport Equipment Transport Services Transport Insurance Communication Recreational & Personal Services Package Holidays & Accomodation Other Recreational & Personal Services Non-Catering Recreational & Personal Services Catering Services Miscellaneous and Other Services Miscellaneous Services Medical Services Education Special aggregates Durables Semi-Durables Non-Durables Seasonal Food Non-Seasonal Food Energy, Food, Alcohol & Tobacco Energy & Non-processed Food Energy & Seasonal Food Education, Health & Social Protection CPI excluding: Energy Energy, Food, Alcohol & Tobacco Energy & Non-processed Food Seasonal Food Energy & Seasonal Food Tobacco Alcohol & Tobacco Liquid Fuels, Vehicle Fuels & Lubricants Housing, Water, Electricity, Gas & Other Fuels Education, Health & Social Protection Source: National Statistics

17 Table 4: Contributions to CPI percentage change over 12 months Food and Alcoholic nonalcoholic beverages & tobacco beverages Clothing and footwear Housing, water, electricity, gas and other fuels Furniture, household equipment and routine maintenance Health Transport Communica tion Recreation and culture Education Hotels and restaurants Percentage points Miscellane ous goods and services All divisions 2003 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Source: National Statistics

18 Table 5: Contribution to change in the CPI annual rate Food and Alcoholic nonalcoholic beverages & tobacco beverages Clothing and footwear Housing, water, electricity, gas and other fuels Furniture, household equipment and routine maintenance Health Transport Communica tion Recreation and culture Education Hotels and restaurants Percentage points Miscellane ous goods and services All divisions 2003 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Source: National Statistics