Q&A - What is inflation and how is it measured?

Inflation is a sustained increase in the average price level of a country. The rate of inflation is measured by the annual percentage change in the level of prices.

A sustained fall in the general price level is called deflation – in this situation, the rate of inflation becomes negative

In the UK there are two measures of general price inflation, the preferred measure being the Consumer Price Index (“CPI”):

• The government has set the Bank of England a target for inflation (using the CPI) of 2%
• The aim of this target is to achieve a sustained period of low and stable inflation
• Low inflation is also known as price stability

The recent history of UK inflation (as measured by the CPI) is shown in the chart below:

After a long period of low inflation, the UK suffered higher inflation during 2008. However, the recession of 2009 has reduced inflationary pressures and may even lead to a period of deflation.

Interest rates are used by the Bank of England as a key weapon to control inflation. The Base Rate fell to a low of 0.5% in 2009 as fears of deflation and prolonged recession grow stronger. You can see the relationship between interest rate decisions and the CPI inflation rate in this chart: