The Government and the UK Statistics Authority (UKSA) have launched a consultation, relevant to the United Kingdom, on UKSA’s proposals to address the shortcomings of the Retail Prices Index (RPI) measure of inflation. The consultation covers the timing and technical matters for implementation of the proposals. In essence, the key proposal is that, from the implementation date, the RPI index values will be calculated using the same methods and data sources as are used for the Consumer Prices Index including owner occupiers’ housing costs (CPIH). The consultation is open for six weeks, closing on 22 April. The Government and UKSA will respond to the consultation before the parliamentary summer recess.
The RPI is the oldest measure of inflation in the UK and is used widely across the economy and in financial contracts and other transactional documents. However, it has shortcomings meaning that it has sometimes overestimated, and at other times underestimated, the rate of inflation. The shortcomings include in the index formulae that it uses to aggregate some price changes, the treatment of housing costs, population and geographic coverage. The RPI lost its National Statistic status in 2013.
Despite the shortcomings, Government continues to have a major use of the RPI especially in its issue of index-linked gilts, which use the RPI to adjust their coupon payments and in the repayment of the principal.
The CPIH (Consumer Prices Index including owner occupiers’ housing costs) has been the Office for National Statistics (ONS)’s lead measure of inflation since March 2017. Since 2010, the rate of RPI annual inflation has been on average 1% point per annum above the CPIH. The effect of the different formulae that the RPI uses accounts for around 0.7 % point of this difference, which is mainly attributed to clothing prices.
In 2019 the UKSA, which is independent from Government and responsible for official statistics on UK inflation measures, made recommendations to address the shortcomings of RPI. The Chancellor subsequently announced that he would consult publicly on when the change should be made.
The Government has no plans to remove the requirement for UKSA to compile and maintain the RPI and publish it every month. However, the UKSA is minded to address RPI’s shortcomings by bringing the methods and data sources from the CPIH into the RPI. This means that from the implementation date the RPI index values will be calculated using the same methods and data sources as are used for the CPIH.
Monthly growth rates will be identical to CPIH monthly growth rates from the outset, but annual growth rates will differ from CPIH annual growth rates for a further year. For the transition period RPI annual growth rates may be higher or lower than CPIH annual growth rates, but once fully implemented, the annual and monthly growth in the CPIH and RPI will be equal.
The RPI and CPIH will continue to be calculated separately and will be published as separate indices and growth rates. Only an all-items RPI will continue to be published; supplementary indices such as RPIX and lower level detail will be discontinued, with guidance provided on the equivalent CPIH indices.
The introduction of the new data source and methods to the RPI will see its annual measured rate of inflation be lower, on average, by 1% point per annum.
Impact of proposals
A major point of concern is the impact of the proposals on the index-linked gilt market and consequently on the public finances. This is an area of uncertainty and the consultation requests information to understand this more clearly, as well as the impact of the timing of the change, whether it is in 2025, 2030 or a year in between.
The Government is also mindful of the potentially wide-ranging impact of the proposed changes to RPI and of their responsibilities as public sector bodies to consider this in future policy making. They do not have full sight of the use of RPI in the economy, including in financial contracts. Impacts from the change to RPI could have unintended and diverse impacts, affecting the public finances, economy, financial markets or groups of users. An example in a property context is the use of RPI to calculate rent increases for leasehold properties. The Consultation seeks information detailing those impacts.
The pensions industry also has serious concerns on the impact of the proposals on pension scheme benefits and investments and the implications for scheme funding levels. See our previous Law-Now for more about the pensions implications. However, this is a consultation on technicalities and there is no suggestion that there will be any change in the key proposal to calculate RPI index values using CPIH methods and data sources.
In terms of contracts that will be entered into that refer to RPI, consideration should be given to what if any changes are needed to calculations if and when the RPI index values are calculated using new methods and data sources.
Responding to the Consultation
Details of how to respond to the Consultation can be found here.