What is inflation? Why prices rise and how it is measured
What is inflation? How prices are measured, why they rise, why central banks aim for 2% and the latest rates in the US, UK, euro area, India and Pakistan.
Why it matters
Inflation decides how far your pay and savings stretch, and it drives the interest rates on loans and mortgages. Knowing how the number is built makes each monthly release easier to read.
Inflation is the rate at which prices rise. When the US Bureau of Labor Statistics (BLS) reported 3.7% inflation for September 2026, it meant a typical basket of goods and services cost 3.7% more than it did in September 2025.
Quick answer: Inflation measures how fast the average price of what households buy is rising, usually compared with the same month a year earlier. Most central banks in rich economies aim for about 2% a year. A fall in inflation means prices are rising more slowly, not that they are coming down.
Inflation is climbing again in 2026. As of October 2026 the annual rate stood at 3.7% in the US, 3.5% in the UK and 3.8% across the euro area, all well above the 2% targets their central banks work to. The statistics offices point mainly to fuel and energy, which jumped after conflict in the Middle East pushed up oil prices.
That makes this a good moment to understand what the monthly figure does and does not tell you, because the answer shapes your rent, your pay talks and the interest rate on your loans.
How statisticians turn hundreds of prices into one number
The method is old and fairly simple. A statistics office picks a “basket” of goods and services meant to represent what a typical household buys, then goes back to the same shops, websites and service providers every month to record the prices. In the UK, the Office for National Statistics (ONS) checks about 700 items, from bread and bus fares to cars and package holidays, according to the Bank of England.
Each item counts in proportion to how much households spend on it, so a 10% rise in rent matters far more than a 10% rise in the price of matches. In the US basket, shelter (rent plus an estimate of what homeowners would pay to rent their own homes) carries about 35% of the weight. Food carries about 13.5% and energy about 7.4%, according to BLS figures for August 2026.
The weighted total becomes a consumer price index (CPI), and inflation is the change in that index over 12 months. You can reproduce the headline figure with three numbers from the BLS release:
- Find the index for the latest month. The US CPI stood at 336.940 in September 2026 (where the 1982 to 1984 average equals 100).
- Find the same month a year earlier. It was 324.800 in September 2025.
- Divide and subtract one. 336.940 divided by 324.800 is 1.0374, a rise of about 3.7%, the figure the BLS published.
The basket changes slowly over time. The ONS now takes supermarket scanner data covering about half the UK grocery market, around 300 million price points a month, in place of the roughly 25,000 grocery prices its collectors used to record by hand.
Headline, core and CPIH: three readings of the same month
The headline rate covers everything in the basket. “Core” measures strip out prices that swing sharply, such as energy and food, to show the trend underneath. In September 2026 the gap was wide, because fuel was doing most of the work:
| Economy | Headline inflation | Core inflation | Month |
|---|---|---|---|
| United States | 3.7% | 2.6% | Sep 2026 |
| United Kingdom | 3.5% | 2.8% | Sep 2026 |
| Euro area | 3.8% | 2.5% | Sep 2026 |
Source: BLS, ONS and Eurostat, October 2026.
Two other names turn up in the news. The UK publishes CPIH, which adds the housing costs of people who own their homes; it was 3.6% in September 2026. And the US Federal Reserve does not target the CPI at all. Since January 2012 its official goal has been 2% inflation as measured by the personal consumption expenditures (PCE) price index, which covers a wider range of spending than the CPI.
Where the 2026 rise is coming from
Economists usually sort the causes of inflation into a few groups. Costs can rise, as when energy, raw materials or wages get dearer and businesses pass some of it on. Demand can outrun supply, when households, firms and governments together try to buy more than the economy can produce. And expectations can feed on themselves: if workers and firms expect prices to keep climbing, they build that into pay claims and price lists, and the expectation helps make itself true.
The 2026 numbers point clearly at the first group. US gasoline prices were up 34.2% in the year to September, UK motor fuel was up 29.8% and euro area energy prices were up about 19%, according to the BLS, the ONS and Eurostat. Strip out energy and food and US inflation was 2.6%, not far from target.
The best recent evidence on how this kind of shock plays out comes from the last one. In a 2023 study of the post-pandemic surge, former Fed chair Ben Bernanke and former IMF chief economist Olivier Blanchard found that most of the jump in US inflation came from shocks to prices (energy, food and shortages of particular goods) rather than from an overheated jobs market. Tight labor markets mattered less at first, they found, but their effect on inflation lasted longer. In their data the number of job vacancies per unemployed worker rose from under 1.0 in April 2021 to 1.9 a year later.
That finding explains why central bankers in 2026 are watching wages more closely than the pump price. A fuel spike on its own tends to fade once oil stops rising. It turns into lasting inflation if it spreads into pay. In September 2026, Bank of England policymakers noted that the knock-on effects of energy on other prices had so far been weaker than they expected, and that private sector regular pay growth had slowed to 2.9% in the three months to July. The split vote that followed, covered in our guide to central bank interest rate decisions, was an argument about how long that would last.
Inflation falls, prices don’t: the most common misunderstanding
Inflation goes down often. Prices rarely do.
When inflation falls from 4% to 2%, prices are still rising, only more slowly. The Bank of England makes this point plainly in its guide for the public: lower inflation is not the same as falling prices. Prices fall only during deflation, when the inflation rate drops below zero.
UK inflation peaked at about 11% in 2022, according to the Bank, and then eased. Because the rate never went negative, the prices of 2022 became the new floor rather than reversing. What restores buying power after a burst of inflation is pay rising faster than prices for a while, which is a slower and less visible process than the original price jump.
Central banks do not want prices to fall across the board either. The Bank of England warns that deflation can squeeze business income until firms cut wages and jobs, and people who expect lower prices tomorrow put off spending today.
Why 2%? A number with a history
The 2% target looks like a law of nature. It began as a practical choice in New Zealand. In March 1990 the government and the Reserve Bank of New Zealand signed the first formal inflation target, aiming for 0% to 2% by 1992, when inflation there was running at a little over 5%. Many central banks followed over the next two decades. The Fed made its 2% goal official only in January 2012, and the European Central Bank (ECB) changed its wording in 2021 from “below, but close to, 2%” to a symmetric 2%, meaning misses on either side count equally.
There are two main reasons the target is not zero. The first is measurement. A 1996 US commission led by the economist Michael Boskin estimated that the CPI overstated inflation by about 1.1 percentage points a year, largely because it missed improvements in quality and shifts to cheaper shops and products. The BLS has since changed its methods, and a later NBER review put the bias closer to 0.65 points. A small amount of measured inflation may therefore be no real inflation at all, and a measured zero could hide falling prices.
The second reason is room to act. Central banks fight downturns by cutting interest rates, and rates cannot go far below zero. Normal interest rates tend to be higher when inflation runs at 2% than at zero, which leaves more room to cut before hitting that floor. In 2010, Blanchard and two IMF colleagues went further and asked whether a 4% target would leave more room still. Central banks did not take it up, and the proposal met especially strong resistance in Germany.
Targets are higher in many emerging economies, where prices have historically risen faster and food takes a bigger share of household budgets:
| Economy | Latest inflation | Central bank target |
|---|---|---|
| United States | 3.7% (Sep 2026) | 2% (PCE measure) |
| United Kingdom | 3.5% (Sep 2026) | 2% |
| Euro area | 3.8% (Sep 2026) | 2% |
| India | 5.54% (Sep 2026) | 4%, within 2% to 6% |
| Pakistan | 10.26% (Sep 2026) | 5% to 7% over the medium term |
Source: BLS, ONS, Eurostat, India’s Ministry of Statistics, Pakistan Bureau of Statistics and central bank websites, October 2026.
India’s figure comes from a new CPI series with 2024 as its base year, and there it was food, not fuel, that drove September’s rise: food prices were up 7.74% on a year earlier. India’s government renewed the Reserve Bank of India’s 4% target for another five years from April 2026. Pakistan’s rate eased from 11.15% in August.
Why your own inflation rate is not the official one
The official figure is an average across all households, and almost nobody is average. A commuter who drives 50 miles a day felt the 2026 fuel jump far more than someone who walks to work. A renter feels rent rises that a homeowner on a fixed mortgage does not.
Housing is where the gap between the statistics and daily life is largest. In the US, shelter makes up about a third of the CPI, and much of it is an estimate of what owners would pay to rent their own homes, built from surveys of existing tenants. As the Brookings Institution has explained, the BLS revisits each sampled home only every six months, and most rents change only when a lease ends, usually once a year. The measure therefore picks up turns in market rents late, so US shelter inflation can keep rising after new-lease rents have cooled, and the reverse.
Frequency shapes perception too. Fuel and groceries are bought every week, so their prices stick in the memory far more than a washing machine bought once a decade. The ONS runs an online shopping prices comparison tool that tracks more than 650 individual items and lets users build their own basket, which is a useful check on whether your experience matches the headline.
How to read the next inflation release
Look past the headline in three places. First, the monthly change: US prices rose 0.6% in September 2026 alone, a pace that would mean more than 7% if it lasted a year. Second, the core rate, which tells you whether the rise is spreading beyond fuel and food. Third, base effects. The UK annual rate jumped from 3.1% to 3.5% in September partly because prices rose 0.4% in the month, against almost no change in September 2025. When a big monthly rise drops out of the 12-month window, the annual rate can fall sharply even though nothing got cheaper.
These are the next dates that will show where inflation is heading:
- 28 Oct 2026: The US Federal Reserve announces its interest rate decision.
- 29 Oct 2026: The European Central Bank announces its decision.
- 10 Nov 2026: The BLS publishes US inflation for October.
- 18 Nov 2026: The ONS publishes UK inflation for October.
The number to keep in mind is the gap between headline and core. In September 2026 it was more than a full percentage point in the US. If that gap closes because fuel prices settle, the energy shock is passing; if it closes because core inflation climbs, the shock is spreading. Our explainer on stock market indexes covers how markets tend to read those releases.
This article is for information only and is not financial advice.
