What is Inflation?

What is Inflation?
What is Inflation?What is Inflation?

The Office of National Statistics (‘ONS’) releases information about the rate of inflation each month.  The inflation rate shows how much prices have risen in the previous 12 months, since the same day the previous year.

The current rate of inflation, released on 18th October 2022, is 13.2%. The inflation rate was calculated from September 2021 to September 2022. The rate of inflation for August 2022 (compared to prices in August 2021, released in September 2022), was 13%.

Inflation at 13.2% is the highest 12-month inflation rate since the Office of National Statistics started recording it using the current method of calculation, in January 1997.


What does this mean?

Inflation shows the decrease in the purchasing power of money - our money doesn’t go as far as it did 12 months ago. The inflation rate is the general increase in the prices of goods and services in the UK. The same purchases we made 12 months ago, now costs us, on average, 13.2% more.

In a market economy, prices for goods and services fluctuate. Some go up in price, some go down. Inflation happens if there is a broad increase in the cost of goods or services. It is not calculated on single items.

The inflation rate is calculated using the Consumer Prices Index (otherwise known as the ‘CPI’). The Consumer Prices Index measures the change in prices over a 12-month period of a representative ‘basket’ of items and services. This is the most widely used measure of inflation.

There are 520 items in the ‘basket’ and these include food items; alcohol and tobacco; clothing and shoes; fuel for cars; the cost of heating our homes; electronic goods; holidays and flights, personal care items; books and newspapers; games and toys and more. These are everyday items that households purchase. To see the full list of items, click here.


As we spend more money on some things rather than others, the items in the ‘basket’ are ‘weighted.’ For example, if fuel for cars increases by 15% in price, it has more of an impact on our personal finances than if the cost of a bottle of shampoo rises by 15%. This is because of the relative amount of our disposable income we spend on fuel and the frequency of our purchases. The ‘weighting’ reflects the importance of the various items in the ‘basket.’


How is the Consumer Price Index calculated?

The ‘basket’ of items stays the same each month so prices can be calculated on a like-for-like basis. Each month, over a hundred thousand prices are collected at over 150 locations in the UK. In total, over 180,000 prices are collected. Around 100,000 prices are collected in person, by price collectors, and around 80,000 are collected centrally by the Office of National Statistics.

The price collectors visit the shops to record the prices for specific items. They visit the same shops each month and record the prices of the same products. The information collected is treated confidentially, with no retailer-specific information being shared with any party outside of the Office of National Statistics and the contractors who collect the data.

So that the ‘basket’ is representative of the things that we buy, it is reviewed and updated annually.

Once the data has been collected, it is processed and calculated. Changes in prices of the individual goods and services in the Consumer Prices Index are compared to their levels from the same month in the previous year. They are then weighted using the weights (the importance) for the current year to produce an overall average price change.

The final stage in the process is to link the average price changes with the figures for earlier years.


What other calculations are used to work out inflation?

The Consumer Price Index is the most widely used measure of inflation, but it’s not the only index used. The other index is the known as the CPIH, which is the Consumer Prices Index including owner occupiers' housing costs. CPIH extends the Consumer Price Index to include a measure of the costs associated with owning, maintaining and living in our own homes. These are known as owner occupiers’ housing costs (‘OOH’). Council tax is also included in CPIH. Mortgage interest payments are not included in the CPIH.

The ’basket’ of items measured by the Consumer Prices Index and the Consumer Prices Index with owner occupier housing costs is the same. The only difference between the two indexes in the inclusion of the measure of owner occupiers’ housing costs in the CPIH.


How is inflation controlled?

Once the rate of inflation has been established – at the time of writing, at 13.2% - it's the responsibility of the Bank of England to set the monetary policy to try and prevent it from increasing further. The Bank of England’s target inflation rate is 2%.


The main way the Bank of England does this is through increasing interest rates. Interest rates reflect the amount of money that people get in interest on their savings as well as the charge they need to pay for having loans, credit and mortgages. Savers benefit by an interest rate increase, borrowers are disadvantaged. At the time of writing, the interest rate set by the Bank of England is 2.25%. There has been market talk that this may rise to 4.25% by December 2022, and around 5% by the second quarter of 2023, but this is unconfirmed.

By increasing the Bank of England base rate of interest, this leads to a reduction in demand for goods and services as they cost more. This reduces inflationary pressure because people restrict their spending.


How does PayCaptain help?

In times of increased cost of living, more financial pressure is placed upon the whole population but particularly impacts those of lower income households. PayCaptain was launched to pay employees irrespective of their financial position, but it has a wealth of innovative features to help those who are more financially vulnerable. The PayCaptain solution offers the following functionality to help employee’s financial well-being:

-       On demand pay – where companies can give their employees access to payments when they need them, even if it’s outside of the regular pay period

-       Payment splitting – where employees can make payments direct from their net pay to family members, landlords, loans, credit cards, etc – eliminating risk of missing an important payment

-       Savings - employees can pre-plan the amount to save and is automatically transferred from net pay. This builds some resilience for times of financial hardship

-       Money planning tool – where employees can create a personal budget

-       Personalised financial guidance – trusted financial guidance from Money Helper can be accessed directly through the PayCaptain app

-       Pensions – to make provision and build better financial resilience for later life


In summary, the rise in the inflation rate to record levels of 13.2% in October 2022, demonstrates a decrease in the purchasing power of the money that we earn. Our money doesn’t go as far as it did 12 months ago. The same purchases we made this time last year now costs us, on average, 13.2% more. PayCaptain offers solutions to improve employees financial well-being in these times of hardship.


To learn more about how PayCaptain can help your business and improve the financial well-being of your employees, please contact us for an informal, no-obligation chat. We’ll be happy to demo PayCaptain for you.

Blog updated October 2022 to reflect the rising inflation figure and Bank of England base rate.