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The UK inflation rate fell to its lowest level in 14 years in December 2014, meaning that it is now at just 0.5%, so what does this mean for consumers?

The Consumer Prices Index (CPI) – the way that inflation is generally measured – grew by just 0.5% in the last month of the year, lower than the 1.0% increase recorded in November. This means that inflation is now more than one percentage point below the Bank of England’s target of 2%. Unless you work in economic forecasting, you might be wondering what this all means and – more importantly – how it can affect you and your family’s budgeting.

What’s inflation and why does it matter to me?

To put it simply, inflation is how fast the price of products and services households buy are rising. As mentioned above, the main way that inflation is measured is by the CPI. The CPI tracks the price of some of the things that we all buy most frequently, including food, clothing, alcohol, and petrol. If the average cost of these goods and services increases over a year, that’s inflation. Another way that the rate of inflation is tracked is through the Retail Prices Index (RPI), which also includes the cost of mortgage payments and other housing costs.

CPI inflation is expressed as a percentage, currently at 0.5%. This means that the price of the consumer goods and services measured will cost you 0.5% more than it did this time last year. According to some analysts, the main reasons for the fall in inflation is the supermarket price wars and the tumbling petrol prices that we’ve been hearing a lot about in the news in recent weeks.

Is the fall in inflation a good thing?

For most consumers, low inflation is generally good news. It means that the cost of living is hardly going to go up, so for families living on a budget, this is great to hear. If you were to spend £50 a week on your food shopping, it would theoretically cost just 25p more than it did last year. This will benefit consumers as the cost of living will stay more affordable so you should be able to make your money go further.

If your earnings are rising less quickly than prices, then over time your take home pay will be worth less in terms of what you can buy for it. Lower inflation may make it more likely that your income will increase faster than prices – giving you more purchasing power.

It also means that interest rates are likely to stay lower for longer, with some predicting that they won’t rise for another year. This is good if you’re borrowing or looking to buy a house, as the interest rates on these are likely to be lower.

What are the downsides?

Low inflation isn’t all good news for consumers though. Some pay and benefits rises are linked to the inflation rate so you might find your income doesn’t rise much (or at all) while the inflation rate is so low. If inflation stays this low for a long time, it could have a serious effect on wages. However, as some analysts are predicting that inflation will start to rise again in the coming months, we don’t need to worry just yet!

The other way that low inflation could affect you is if you owe money – for example on a mortgage. Over time inflation erodes the value of debt. For example if you ask somebody who bought a house back in the 70s or 80s who much their mortgage was, chances are that it was only a few thousand pounds. At the time it was a lot of money – but inflation has eroded its value. So low inflation means that the real value of what you owe doesn’t go down as fast.

It is slightly better news for savers. With interest rates so low it has been a real struggle trying to find a savings rate that gave a “real” return – in other words the interest rate on savings hasn’t been high enough to keep up with the rise of prices, so your savings were actually going down in value. Lower inflation means that more savings accounts actually give a positive “real” – after inflation – return.

There is also a risk that if inflation falls too much, we might end up with deflation, where goods start to have lower prices than they did a year ago. While this may seem like a good thing in theory, it can lead to a big slowdown in the economy. Put simply, if you know that the goods that you want to buy today (say a TV) will be cheaper next month you might end up delaying the purchase. This could lead to a slowdown in consumer spending which would be bad for the economy.

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