A falling inflation rate can sound like a promise of cheaper shopping. It describes a change in the pace of price increases, however, rather than a return to an earlier price level. The distinction becomes clearer when you work through a fixed basket of purchases.
All amounts and rates below are hypothetical teaching examples, not current inflation data or forecasts. The calculations hold the basket unchanged so that its price can be compared over time.
A €100 basket with slower inflation
Start with a basket costing €100. A 5% increase takes it to €105: €100 × 1.05. If the next increase is 2%, apply that rate to €105, not to the original €100. The new cost is €107.10: €105 × 1.02.
Inflation has slowed from 5% to 2%, but the basket has become €2.10 more expensive in the second period. Across both periods it costs 7.1% more than at the start. Adding 5 and 2 gives a rough approximation; multiplying the two factors gives the exact compounded change.
Percentages and percentage points
The move from 5% to 2% is a fall of 3 percentage points. Measured relative to the original rate, the decrease is 3 ÷ 5 = 60%. Those statements describe the same change in the rate. Neither means that the price of the basket has fallen by 3% or 60%.
How far does a pay rise go?
Suppose income rises from €1,000 to €1,030 while the price of an unchanged basket rises by 5%. Income is up 3%, but €1,030 divided by 1.05 buys the equivalent of about €980.95 at the old prices. In this simplified example, purchasing power falls by about 1.90%. Subtracting 5% from 3% gives an approximate change of −2%; division gives the more precise result.
This is not a calculation of any reader’s actual household budget. Your spending mix, taxes, housing costs and changes in quantities can produce a different result.
Three checks when reading an inflation headline
First, identify the comparison period: a monthly change and a change from the same month a year earlier answer different questions. Second, check which index and country the story covers. Third, separate the rate of change from the price level before drawing conclusions about affordability.
For an official explanation of inflation and weighted consumer baskets, see the European Central Bank’s inflation explainer. The numerical scenarios here are constructed examples. This article explains arithmetic and terminology; it does not recommend financial products.