What is inflation? Rate rises to 2.2% in July in first increase this year

The annual inflation rate rose for the first time this year in July.

However, inflation had been expected to rise to 2.3% so most City analysts believe the smaller-than-predicted rise is unlikely to delay another interest rate cut. Inflation last rose in December 2023 when the CPI increased from 3.9% to 4%.

The ONS said the main reason for the inflation rate rise was that gas and electricity prices did not fall as steeply as they had in the same month last year.

Darren Jones, Chief Secretary to the Treasury, said: “The new Government is under no illusion as to the scale of the challenge we have inherited, with many families still struggling with the cost of living. That is why we are taking the tough decisions now to fix the foundations of our economy so we can rebuild Britain and make every part of the country better off.”

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

Inflation in the UK refers to the rate at which the general level of prices for goods and services increases, causing a reduction in the purchasing power of the pound sterling (£). As inflation rises, each pound buys less than it did before.

The next CPI release date is expected on September 18, which will cover August.

Here are the dates for the rest of the year:

The final 2024 inflation reading (covering December) will be released early in the new year on January 15, 2025.

Various factors can drive up prices or inflation in an economy. Typically, inflation results from production cost increases or rising demand for products and services.

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

Inflation is primarily caused by two main factors: demand-pull and cost-push pressures.

Demand-pull inflation occurs when consumer demand exceeds the available supply of goods and services. Factors such as increased consumer spending; fiscal policies that boost government expenditures or cut taxes; and monetary policies that lower interest rates, making borrowing cheaper, can drive this.

When demand outpaces supply, businesses raise prices to capitalise on the heightened demand, leading to inflation.

On the other hand, cost-push inflation arises from increased production costs that businesses pass on to consumers. Factors contributing to cost-push inflation include rising costs of raw materials, labour, and energy — and supply chain disruptions and geopolitical events. When businesses face higher costs, they often raise prices to maintain profit margins, thereby pushing up the overall level of prices in the economy.

Additionally, built-in inflation, driven by expectations of future price increases, and monetary factors such as money supply and interest rate changes also play significant roles in shaping inflationary trends.

External factors including global commodity prices and exchange rate fluctuations can further influence inflation by affecting production and imported goods’ costs. Governments and central banks employ monetary and fiscal policies to manage inflation, aiming to maintain stable prices while fostering economic growth.

In the UK, inflation is primarily measured using the CPI, which tracks the average change over time in the prices consumers pay for a basket of goods and services. The ONS compiles and publishes the CPI monthly.

The calculation involves selecting a representative sample of goods and services commonly purchased by households, including categories such as food, housing, transport, clothing, and recreation.

To calculate CPI inflation, the ONS collects price data for these items from thousands of retail outlets across the UK. Prices are weighted according to their relative importance in the average household’s spending. Each month, the ONS compares the current prices of the items in the basket to their prices in a base period, typically set to a specific year (currently 2015 in the UK).

The percentage change in the CPI from the base period to the current one gives the inflation rate.

The CPI is adjusted periodically to reflect changes in consumer behaviour and spending patterns. It includes various versions such as CPIH (including owner-occupiers’ housing costs) and RPI, although CPI is generally preferred for official purposes.

The Bank of England uses CPI inflation as a key indicator in its monetary policy decisions, aiming to keep inflation close to a target set by the Government, typically around 2% per year.

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% a month. This caused the economy to collapse and forced countless citizens to flee the country.

In the 2000s, Zimbabwe experienced hyperinflation, with inflation rates soaring to several thousand per cent annually. This hyperinflation devastated the economy, eroded savings, caused severe shortages of goods and services, and led to social and political unrest.

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 with 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 pays for a certain time — usually two years or five years.

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

Inflation affects wages by reducing their purchasing power. If wages don’t increase at the same rate as inflation, real wages — what your income can buy — decline, meaning you can afford less despite earning the same amount.

In response, workers may seek higher wages to keep up with the rising cost of living. However, if wage increases lag behind inflation, employees face a loss in real income.

In some cases, wage increases can lead to a wage-price spiral, where higher wages drive up business costs, leading to further price increases. This dynamic is particularly challenging for low-income workers, who spend most of their income on essentials. This makes them more vulnerable to inflation.