HERE is the big financial shock of the week – and no, it is nothing to do with another failed banker walking off with a massive pension. Inflation, which was expected to fall sharply, has risen instead.

Experts had expected the Consumer Price Index (CPI), which does not include mortgages, to fall from January’s three per cent. Instead, it rose to 3.2 per cent.

Meanwhile the Retail Price Index (RPI), which does include mortgages, had been expected to dip below zero for the first time since 1960. That would have seen the country entering a period of deflation, instead of inflation. But while RPI did fall, it only went down very slightly, from 0.1 per cent in January to zero. Effectively, prices remained level over the month instead of starting to go down as had been expected.

The rise in CPI means inflation is still higher than predicted, and still considerably above the Government’s target of two per cent.

Bank of England Governor Mervyn King said that was probably due to the weak pound pushing up the price of imported goods.

But which is worst, inflation or deflation? And how does it all affect you?

Inflation means things are getting more expensive – deflation that they are becoming cheaper. On the face of it, you might think we could do with a bit of deflation. Not so, says York financial adviser Stuart Matheson, of Grosvenor Financial Consultants. Deflation is bad for the economy because it stops us buying things.

“Deflation might cause you to delay buying things because you know they are going to get cheaper. But if we’re not spending money on stuff, then you need fewer people to produce that stuff, and if you have fewer people producing stuff that is fewer jobs, and more people claiming benefit and not paying tax.”

Deflation is also bad if you have debts, says Stuart – and that is true whether you are a government or just an individual with a big credit card debt.

If you are in debt, inflation is good because it “inflates away the debt”. Think of that £20,000 mortgage your parents took out 25 years ago. It seemed a huge sum then. But even if they hadn’t paid off a penny of capital in 25 years, that £20,000 today seems much less, because money isn’t worth what it was 25 years ago, thanks to inflation.

If we enter a period of deflation, however, our debts will effectively increase.

The big question now concerning economists, therefore, is whether or not we are going to enter a period of deflation. That could have a huge effect on the speed with which we pull out of recession.

For the ordinary man or woman on the street, however, the equation is simpler. Are prices going up, and can we afford them?

Forget RPI or CPI, says Stuart. The fact is that different people with different lifestyles will have different personal rates of inflation, depending on the things they do and don’t buy.

Here is how you might be affected:

The young couple

AS LONG as you are still in a job, there are pluses and minuses.

House prices are low and mortgage rates have dropped sharply. So provided you can get a mortgage – and that is a big ‘if’ – you will do well.

The price of new and used cars has also fallen. Petrol prices, while now creeping up again, are much lower than a few months ago – and hopefully we might see those more reasonable fuel prices reflected in gas and electric bills, too.

Imported foods will be more expensive, but supermarkets are keen to keep the price of important basics as low as possible, says Stuart. And with retailers desperate for sales, there should be bargains out there for those looking for clothes.

The big downside, apart from being unable to get a mortgage, is that with the recession your wages may have been frozen. And there is always the risk you could lose your job.

The family

OLDER couples with families are likely to already have a mortgage – and as long as they are not on fixed rates, should have seen payments fall sharply. Some people on tracker mortgages are paying as little as £1 a month, says Stuart.

Petrol is cheap, and as long as you stick to the basics and avoid too many imports, food should not be too expensive. Electronic goods such as iPods and computer games for the children traditionally come down in price over time – but that has to be balanced by the increased cost of importing goods, because of the weak pound.

The same is true of toys. Again, there are clothes bargains around, although expensive imported fashions might be even more expensive, because of the weak pound.

The pensioner

PENSIONS traditionally do not keep up with earnings – so pensioners tend to fall behind. You probably don’t have a mortgage any more, so won’t benefit from the low rates, and bills such as council tax, which tend to go up faster than inflation, represent a bigger proportion of income than most. You probably don’t often buy mobile phones or iPods, so won’t benefit from cheaper electronic goods.

Against that, food and fuel prices are not too bad.

Nevertheless, your personal inflation rate is likely to be higher than average, because of the things you buy and don’t buy. “Retired people tend to have a greater rate of inflation than most others,” according to Stuart.

The benefits claimant

BENEFITS go up from next month, many of them by between £3 to £4. Jobseekers Allowance and council tax allowance for those over 25 will rise from £60.50 a week to £64.30 (a 6.2 per cent increase), carer’s allowance from £50.55 to £53.10 (a five per cent increase) and attendance allowance from £67 to £70.35 (a 6.5 per cent increase).

These increases are all above CPI, but benefits have never been adequate, says Rosemary Suttill, a manager at York Citizen’s Advice Bureau. Then we have the situation where the recession is seeing more people out of work.

“People have been the victims of a set of circumstances beyond their control,” she says.

For these reasons, it is important that everybody claim all the benefits they are entitled to, Rosemary says.