Inflation shows sharp fall on new measure

The UK's chances of meeting the Maastricht criterion on inflation were given a boost yesterday, when the Office for National Statistics (ONS) published a new and sharply lower measure of UK inflation, which was calculated on the same basis across Europe.

The harmonised index of consumer prices (HICP) rose by 2.2 per cent in the 12 months to January, 0.9 percentage points less than the target measure of inflation, which is 3.1 per cent.

Leo Doyle, an economist at Dresdner Kleinwort Benson, said: "It looks a pretty solid bet now the UK will meet the Maastricht criterion on inflation."

At the same time it emerged that the Treasury and Bank of England have both become concerned that the current UK retail price index (RPI) overstates inflation. An investigation has been launched to discover whether it is biased upwards in the same way as the US consumer price index.

The drop in the HCIP compared to the current UK measure caught analysts by surprise. But Mr Doyle said: "The method of calculation is very different." Unlike the RPI, the HCIP includes air fares, new cars and computers - all of which are particularly sensitive to deflationary pressures, so would be expected to push the European index down compared to the RPI.

The ONS said that the European measure also used a different statistical method to calculate average price increases, which reduced the new inflation measure. Other countries have yet to publish their harmonised inflation figures, which could also be lower than existing national measures. But Simon Briscoe of Nikko Europe said: "I would be very surprised if we didn't see an improvement in the UK's relative inflation performance." That should increase the chances of the UK meeting the Maastricht criterion on inflation, which says inflation must not be more than 1.5 percentage points higher than the three best performing countries.

The financial markets are likely to embrace the new measure because it makes international comparisons easier. The ONS was careful to make clear that "the HICP does not replace the retail prices index, which remains the best indicator of UK consumer price inflation".

But a shift away from the RPI could be hastened by additional doubts that the existing UK measure overstates inflation in the same way as the US consumer price index. A Bank of England working paper last March estimated that RPI inflation could be overstated by 0.35-0.8 per cent a year.

A report in December -known as the Boskin Report after the chairman of the commission that wrote it - claimed that inflation in the US was overstated by 1.1 per cent because measured prices failed to take account of several ways in which the cost of living had fallen.

However, some critics in the US claim the Commission exaggerated its results. It had every incentive to do so because a rate of inflation lower by 1.1 per cent could save up to $1 trillion (pounds 613bn) on inflation-linked social security payments between now and 2008.

Diane Coyle, page 24