Insight article

Lived Inflation Methodology - January 2023

Methodology for calculating and forecasting lived inflation rates
4 min read
Denise LovettEconomist

Calculating Lived Inflation rates

The following data sources are used to create the historical lived inflation rates 

  1. Living Cost and Food Survey (LCFS) for expenditure patterns by various demographic subgroups.
  2. ONS Inflation tables for past price indices data and for the average expenditure weighting used in official figures.

We generate monthly ‘lived inflation’ estimates for different household groups. For each month we match the LCFS expenditure of each group to the ONS categories of expenditure (COICOP). However, we do not include Council Tax expenditure from the LCFS as the ONS indicate that LCFS data alone would likely overstate council tax expenditure. 

The latest available LCFS data runs to March 2021 and for months since then we estimate the lived inflation statistics using actual inflation rates matched with expenditure from the 2019/20 wave of the LCFS. This was the last pre-pandemic wave and we believe it is  likely to be more representative of current expenditure patterns than the 2021/21 wave during which consumers were placed under restrictions such as lockdowns. 

We generate two grouping variables based on household observational data, income quintiles and household composition. These are calculated for each LCFS wave separately.

  • To create income quintiles, we rank the equivalised household income variable (OCED scale) and take 5 equal proportions. The 1st household income quintile represents those in the lowest 20% of income and the 5th income quintile represents the highest 20% of household incomes. 
  • For household composition, we use socio-demographic information to create the following groups: single without children, single with children, couple without children, couple with children, 3 adults or more and retired households.

From these grouping variables we calculate the total expenditure by demographic group for each COICOP expenditure category e.g. the total expenditure spent by single parent households on tea and coffee.

To account for differences in demographic sample sizes over time, a weighting is calculated to ensure consistency over LCFS waves.

From these summed expenditure values, we calculate weights that are the proportion of total expenditure spent on each COICOP category for each demographic group. 

These demographic specific weights are used to reweight the CPIH price level changes to generate an overall lived inflation rate for each demographic group. 

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Forecasting future Lived Inflation rates

The following sources are used to make assumptions about the price rises that will occur for different expenditure classes:

  1. For electricity and gas inflation, we use the average energy bill expected by the  Energy Price Guarantee (EPG), £2,500 until April 2023 and then £3,000 beyond April 2023. However after July 2023 Cornwall Insight are predicting energy bills to fall below the EPG. Therefore after July 2023 we base inflation on the Q3 and Q4 2023 predictions.  
  2. For food inflation, the IGD predicts food inflation to peak in early 2023 but then fall steeply for the rest of 2023. 
  3. For all other categories, we used the Bank of England quarterly inflation forecasts from November 2022 as a basis for overall inflation between February to November 2023. The weighting of expenditure proportions from the Family Spending in the UK 2019/2020 data for Food, Electricity and Gas is used to solve for the average expected inflation for all other classes for each quarter. We predict linear inflation changes between the quarterly inflation estimates.

The specific estimates included in our model are as follows: 

  • For electricity and gas prices, we estimate a 96% increase for Q1 2023, followed by a 52% increase for Q2 2023. Then as energy price cap predictions fall below the EPG, we estimate a 11.7% increase for Q3 2023 then -10.4% for Q4 2023. 
  • For food inflation, we estimate from the IGD november forecasts that food inflation will peak at 18% in January, decreasing to 14.5% in July 2023 but falling faster in the second half of the year reaching 8% in January 2024.
  • For all other categories, based on solving for the Bank of England quarterly predictions, we estimate that inflation for all other categories will be 5.2% in February 2023, 6.7% in May 2023, 7% in August 2023 and 5.3% in  November 2023 with linear changes between each quarter.

Sensitivity tests

As a sensitivity test we ran an alternative scenario in which all categories other than electricity, gas and food, were kept at the current rate of inflation as-at December 2022. However this led to higher than expected overall inflation compared with external estimates e.g. Bank of England.