UK inflation

The newspapers are reporting that inflation surged in December.

They say that “The Office for National Statistics said the increase was mainly due to […] VAT rising back to 17.5%, from 15%.”

At first, this sounds a bit strange, given that VAT didn’t go back up till the first of January, and the new figures are for December.

However, because the VAT rate was lowered to 15% on 1/12/08, December was the first month for a year that saw yearly inflation measured against a month with the same VAT rate.

That is, from December ’08 until November ’09, inflation was measured against the backdrop of lowered VAT, but for December, this effect was cancelled.

The inflation figures for January ’10 through to December ’10 will have an increased VAT rate feeding into them, thereby raising them artificially in the same way that they have appeared too low for the past year.

To show the effect of the lowered VAT rate, I downloaded the inflation figures from the Office for National Statistics and added 1.5 percentage points on to the relevant months (VAT went from 17.5% to 15%, but there are many VAT-exempt products, so I had to pick a lower figure).

The official figures are shown with solid lines in the graph, and my adjusted ones with dotted lines.

It’s clear that deflation never really happened here, and the CPI figures (which the Bank of England are supposed to keep close to 2%) have stayed above 3% almost constantly for two years now.

It makes you wonder why exactly they felt that quantitative easing was needed…