Bank Charges and UK Inflation

Bank Charges and UK Inflation - at - the best of the international financial media

UK inflation figures have been telling a strange tale lately. On the new target measure, known as the Consumer Price Index, inflation has surged past the Bank of England's 2% target, to 2.4% in August, an uncomfortably high level considering that CPI inflation was down at just 1.1% in September 2004.

However on a different measure of inflation, the Retail Prices Index excluding mortgages (or RPIX for short), there is little sign of a threat. RPIX inflation in August was 2.3%, up only modestly from 1.9% at the low in September 2004 and below the Bank's former target - when this was the measure the Bank concentrated on - of 2.5%.

Why are CPI and RPIX telling a different story on inflation? The most obvious difference between the two measures is that the former does not include house price inflation, whereas the latter - correctly in our view - does. However this is not the main reason why the two are behaving differently - if you take all housing costs out of the Retail Prices Index, you get an inflation rate in August of 1.7%, far below the CPI's figure of 2.4%.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

So the real explanation must be elsewhere. One factor is that motor insurance charges, which have been falling recently, have about four times the weight in the Retail Prices Index 'basket' as they do in the CPI basket.

But there is another, more intriguing reason. In the CPI for August, the inflation rate for 'other financial services' reached 11% year-on-year. The Office for National Statistics has told us that this partly reflects increases of 15% to 16% year-on-year in bank overdraft and packaged current account charges.

In the CPI basket, 'other financial services' - which also include foreign exchange commissions, unit trust charges and stockbrokers' fees - have a weight of 26 units out of 1000, no less than 10 times the weight they had in the old Retail Prices Index.

The 'other financial services' category contributed more than 0.2 percentage points to the overall CPI inflation rate of 2.4% in August, and a significant part of this contribution came from bank charges. But the banks might have stuck their heads above the parapet at a bad moment.

Given their apparent ability to pass on substantially higher charges at a time of low inflation, we believe there may be a concentration of market power issue for the competition authorities to look at. However there is a danger that Chancellor Gordon Brown may draw a different conclusion - that Britain's banks, likely to make pre-tax profits of £30bn this year according to City analysts, could provide him with some additional tax revenue in next Spring's Budget. He will recall that his Tory predecessor, Sir Geoffrey Howe, slapped a windfall tax on bank profits in 1980.

By Douglas McWilliams, chief executive at the Centre for Economics and Business Research