What is inflation? Rate falls to 2.3%, lowest in almost three years

Easing tobacco and food price rises also contributed to the lower inflation rate (PA Archive)
Easing tobacco and food price rises also contributed to the lower inflation rate (PA Archive)

Inflation in the UK has fallen to its lowest level in almost three years, with falling gas and electricity prices as the main drivers.

Prices rose 2.3 per cent in the month to April, down from 3.2 per cent in March, according to official figures.

However, inflation still remains higher than the Bank of England's target of two per cent and was slightly higher than expert predictions.

The lower price cap kicked in last month, causing a sharp inflation fall.

Energy prices were 27 per cent lower in April compared to 12 months earlier, while gas prices alone were down 38 per cent.

Easing tobacco and food price rises also contributed to the lower inflation rate.

However, mobile phone bills and rent costs continued to rise.

Prime Minister Rishi Sunak said the figures marked a "major moment for the economy, with inflation back to normal".

“Brighter days are ahead, but only if we stick to the plan to improve economic security and opportunity for everyone," he added.

However, Labour's shadow chancellor Rachel Reeves said now was "not the time for Conservative ministers to be popping champagne corks and taking a victory lap".

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

What is inflation?

Inflation measures the rate at which the prices of goods and services increase. It can occur when prices rise due to production cost increases, such as raw materials and wages.

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

A surge in demand for products and services can cause inflation because consumers are willing to pay more for them.

What causes inflation?

Various factors can drive up prices or inflation in an economy. Inflation results from increased production costs or demand for products and services.

In the short term, high inflation can be due to people having a lot of surplus cash, or accessing a lot of credit and wanting to spend.

Despite consumers receiving little to no benefit from inflation, investors can profit if they hold assets in affected markets. For example, those who have invested in energy companies might see a rise in their stock values if energy prices rise.

How is inflation calculated?

Inflation is calculated by measuring changes in the cost of living, and the official method used is the CPI. It is worked out by measuring the price of a basket of goods and services we use every day. This basket includes everything from eggs to e-books and is regularly updated.

It is determined by the annual Family Expenditure Survey, a voluntary survey of about 6,000 people conducted by the ONS. It helps to determine the percentage of people’s incomes spent on different things.

Once the survey results are in, the Government checks the prices of the 1,000 most common goods in the UK every month. The percentage changes in the price of individual goods and services are noted.

Percentage increases in price are then multiplied by the weighting the particular product category has been given, which shows how much it affects consumer budgets.

How does inflation work?

Inflation occurs when prices rise across the economy, decreasing the purchasing power of money. It refers to the broad price increases across a sector or industry and ultimately a country’s economy.

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

What does inflation mean for mortgages?

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 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 homeowners pay for a certain period — usually two years or five.

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.

What does inflation mean for wages?

When inflation rises — and wages don’t keep up — the real pay value is affected.

This means wages don’t stretch as far as they used to and employees have less purchasing power.