Juggling trick with a shopping bag: The Retail Price Index is measured by a list of some 600 items. How reliable a guide to inflation is it?

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ARE THEY up? Are they down? Is what we see real or is it a conjuring trick? Watching prices can play tricks on your eyes, and the holiday 'price war' which broke out last week left consumers unsure of what they were getting.

After frenzied price-cutting, the travel agents Going Places and Lunn Poly announced reductions of up to 15 per cent in their 1995 charges; Thomson and Airtours, the tour operators, offered deals which included cheap or free places for children.

However, the influential Lex column in the Financial Times dismissed the frantic competition as 'largely a publicity stunt', and one analyst said there was unlikely to be a real 'war'. Kim Winter, of Holiday Which?, warned that the attractive packages could be tied to expensive extras such as travel insurance or flight supplements for travelling on certain days or from certain airports.

Price wars, real or phoney, are one of the pitfalls of working out changes in the value of what you buy. The broader puzzle involves watching changes in the rate of inflation, which measures the average rate at which all high street prices move. Every month, staff from JobCentres and unemployment benefit offices collect 150,000 prices from 180 areas of the country to compile the Retail Price Index. The RPI includes 600 different goods and services - from the price of a dog's food bowl to the cost of sending a red rose to Watford. Not surprisingly, these prices move at different speeds and in different directions. The price of unprocessed potatoes has risen by more than 20 per cent in the last year, while the average price of audio-visual equipment has fallen by 6 per cent. Even fairly similar products can move in very dissimilar ways - the price of beef mince has fallen by 8 per cent in the past year, but pork sausages cost the same.

Inflation for all retail prices is running at 2.6 per cent. After excluding mortgage interest payments, this is the lowest rate for a generation and reflects the lingering impact of the recession, which has forced consumers to tighten their belts. The big question for us all is how quickly a strengthening economic recovery will see the rate of price increases pick up.

So far many high-street stores have been unable to get shoppers to pay more, fuelling price wars between them as they compete for market share. Consumers have become much more willing to spend time comparing prices in different stores rather than plumping for the first suitable item they find.

Prices of clothes and shoes have been particularly subdued since the recession got underway, rising in price by only 0.7 per cent in the last year. A man's suit at Marks & Spencer costs between pounds 120 and pounds 250, the same as last year. In clothes shops throughout the country, summer and winter sales have started earlier and lasted longer. But there are exceptions to every trend: the price of Levi 501 jeans has risen by 13 per cent over the past 12 months - five times the rate of inflation.

Recession is not the only reason why some goods and services have been falling in price. The price of audio-visual goods has fallen by 23 per cent since 1987. Technological progress brings down production costs and means that only the latest products can command premium prices while old models have to be sold off more cheaply.

The RPI tries to take account of technological progress and changes in consumers' tastes, with different items joining and leaving the hypothetical 'shopping basket' every year. This year kippers, stockings and spark plugs left the index, while peaches, leggings and boat trips to the Norfolk Broads came in. Lard, mangles, sanitary towels and tinned rice pudding have all left the index in past years, while muesli, condoms and multi- vitamins have joined.

But even when inflation is subdued, some prices rise rapidly. Officials at the Bank of England are worried that the pace of recovery in the building industry may be pushing up inflation in that sector. The prices of building materials have been rising strongly, with some timber prices increasing by 10 to 15 per cent this year.

Commodity and raw material prices have been rising strongly, pushed up in part by speculative buying from international investors looking for a quick profit. Wool, copper and oil prices have all risen strongly, while frosts in Brazil have pushed up the price of a jar of instant coffee. But in most cases companies have had to absorb higher raw material prices by cutting profits rather than passing them on to the customer. Prices can also rise quickly where competition between suppliers is lax or where demand for a product is high. So the prices of bus and coach tickets have been subdued as rivals battle for custom, while most train fares have risen more rapidly. Ford announced on Friday that it would be raising the prices of its cars by an average of 2 per cent amid forecasts that car sales this month will surpass the all-time record set in 1989.

So the inflation picture remains mixed. Some optimists argue that consumers have undergone a psychological revolution which means that they will never allow retailers to get away with the size of price increases seen in the 1980s. But it is unlikely that the Treasury or the Bank of England will be prepared to take that chance.

Economics, Business, page 6

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