Inflation is the rate of increase in the price of goods and services. The Bank of England is responsible for meeting a target inflation rate to support a stable and healthy economy.

What is inflation?

Inflation is the rate of increase in the prices of goods and services. It is expressed as a percentage. If inflation is 3%, this means that, on average, the price of goods and services is 3% higher than it was a year earlier.

Limited inflation encourages people to spend sooner, which is good for economic growth – if consumers or business anticipate that prices will fall in the future, they are likely to hold off on spending.

How is inflation calculated?

Every month, a team of specialists from the Office for National Statistics (ONS) collects around 180,000 separate prices of about 700 items covering everything from food and drink to clothes, furniture and train fares.

This ‘basket of goods’ is used to calculate the Consumer Prices Index (CPI). The ONS publishes an updated rate every month. This is the inflation measure used in the Government’s inflation target (but there are other measures of inflation).

What is the inflation target?

The Government sets an inflation target for the Bank of England.

Generally, when people feel like spending – in other words when demand for goods and services exceeds supply – inflation tends to rise. When people don’t feel like spending and supply exceeds demand, inflation tends to fall. 

So to meet the inflation target, our Monetary Policy Committee (MPC) changes the official Bank of England interest rate (also known as Bank Rate or the Base Rate). This is the rate of interest that we pay on reserves held by commercial banks at the Bank of England. Generally, banks pass these changes on to customers. So if we raise Bank Rate, these customers tend to receive more interest on savings and/or pay more interest on debt like loans and credit cards, and vice versa. 

So, if inflation looks set to go above target we would probably increase interest rates so people spend less, which tends to reduce inflation. Or if inflation looks likely to fall below target we would probably cut interest rates to boost spending in the economy and help inflation to rise.

If we miss the inflation target by more than 1 percentage point either side – in other words, if the CPI inflation rate is more than 3% or less than 1% – the Governor of the Bank of England must write a letter to the Chancellor. This letter explains why inflation has increased or fallen and what the Bank of England proposes to make sure it comes back to target.

This page was last updated 05 July 2018
Was this page useful?
Add your details...