Inflation – a guide to RPI,CPI and CPIH

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We have heard a lot about inflation and the ‘cost of living crisis’ in the news lately, but do you really know what the inflation figure signifies and how it affects you in real life?  In this blog we aim to give a simple overview of how the inflation figures are calculated and how they relate to your cost of living.

What is inflation?

There are various indices used in the UK to measure inflation, the main ones are the Consumer Price Index (CPI) introduced in 2003, the Retail Price Index (RPI) created in 1947 and a variation of CPI called CPIH which includes owner-occupiers’ housing costs (OOH).  From November 2016 the Office for National Statistics (ONS) designated CPIH as the ‘official’ measure of inflation in the UK, however the other two measures are still widely quoted.

In economics, inflation is an increase in the price of goods and services in the economy (the opposite being deflation).  The result of these price rises is that the purchasing power of your money is reduced, i.e. it costs more money to buy the same amount of something – a situation we are all becoming used to during our weekly supermarket trip.  The measure of this increase is the inflation rate, which is a measure of the annual change in prices in percentage terms.

The ”headline” rate that tends to be quoted by the government and media is the CPI.

How is it calculated?

In the UK the current (May 2022) CPI figure is 9.0%, CPIH 7.8% and RPI 11.1%% – why the difference?

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In the UK the Office for National Statistics (ONS) is tasked with compiling the official inflation figures.  There are subtle differences in methodology in how each index is calculated. But in summary the main differences are as below:

RPI includes mortgage interest payments: this means it is heavily influenced by house prices and interest rates

CPI measures take no account of housing costs: but factors in all the other goods and services that make up household expenditure

CPIH includes housing costs but uses an approach called ‘rental equivalence’: this is not mortgage payments but how much rent the householder would pay for an equivalent property

Both RPI and CPI are calculated using a ‘shopping basket’ of products and services bought by households in the UK, but each with a differing make-up. 

CPI is the main measure used and there are over 700 items considered, covering all areas of household spending; including the price of tea bags and package holidays through to curtains and restaurant bills.

However, one of the difficulties is deciding what an ‘average’ price actually is – for instance the price of a pair of curtains can vary enormously depending on size and quality.  It is clearly impractical to collect data on every pair of curtains sold in every shop in the UK so instead a sample of prices is collected from a range of retailers (including online) to create an average.

According to the ONS over 180,000 prices are collected every month across 140 locations in the UK.  In addition, over 300,000 quotations for housing costs are collected to include in the ‘basket’.

These items are then weighted to approximate the percentage of household spending that is made on any given item.  A smaller weighting is given for one-off small purchases than for something like petrol which is generally bought more regularly.

Flaws in the system

The ONS accepts that no one is “average”, and that the CPI inflation figure may not strictly apply to any one individual or family, but “still gives us a useful yardstick of the impact of inflation on our own pocket or purse”.

The ‘headline’ rate that tends to be used by the government and media is the CPI. Statisticians tend to prefer CPIH, while RPI is either hated or loved depending on whether it makes you a winner or a loser.  RPI tends to be a higher figure than CPI due to the different weightings and calculation method.

But are the figures the ‘real’ rate of inflation?  The inflation figures are a weighted average and so can only give an indication of what is actually happening in the world.  Take for example the phenomenon of ‘shrinkflation’, that’s when your favourite bar of chocolate gets smaller while the price stays the same!  The same thing can happen in services as well – an insurance policy that increases its excess or reduces its cover while maintaining the same premium is another good example.

The government has been accused of ‘inflation shopping’, that is to say using whichever measure of inflation suits it, e.g. CPI when it comes to increasing pensions, but RPI when it is raising rail fares.  The ONS considers the RPI measure to be flawed and has stopped reporting it as an official statistic.  It is still needed however as many Government Bonds have been issued which are required to pay interest on an RPI figure.

The ONS provides a more detailed breakdown of the overall inflation figures which helps us to understand what sectors are driving inflation. However, there is a limit to how granular the data can be, so it is important not to take the headline figure as an absolute, but as a guide to the overall state of affairs, and as a way to monitor the macro trends rather than micro changes.

For more information pop over to the ONS website which has lots of detail on the various inflation measures and how they are used.

https://www.ons.gov.uk/economy/inflationandpriceindices

Let us know if there are any other measures you would like us to look into. 

Get in touch at info@kansomarketing.com

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