Inflation: No change to RPI calculation

Old Bond Street, London There will be no change, after all, to the way the RPI is calculated

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There will be no change to the way the retail prices index is calculated, the Office for National Statistics (ONS) has decided.

After a three-month consultation, the ONS has decided not to bring the RPI more into line with the slower rising consumer prices index (CPI).

Instead, a new additional index of inflation - RPIJ - will be created.

However, the RPI will continue to be used for the uprating of private sector pensions and index-linked bonds.

The National Statistician, Jil Matheson, said: "There is significant value to users in maintaining the continuity of the existing RPI's long time series without major change, so that it may continue to be used for long-term indexation and for index-linked gilts and bonds."

However she stressed that RPIJ - which will use a different arithmetical formula to RPI for calculating average prices - would be a much better measure of inflation and would be promoted as such each month, with the old RPI measure being given much less publicity.

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Britain's Office for National Statistics has decided, when it comes to inflation, it's better to be consistent than to be right”

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The ONS's review was prompted by the fact that the inherent gap between RPI and CPI, which runs at an average of 1.2 percentage points a year, has become increasingly dominated by the so-called "formula effect" - the result of using different methods for calculating the average price of goods and services in the economy.

Any decision to alter the current RPI index, so that it rose more slowly, would have reduced the future pension increases of millions of private sector pensioners and cut the income of investors in index-linked government bonds and savers with index-linked savings certificates.

Decision welcomed

The ONS decision means that RPIJ will be published each month from March 2013, alongside other indices.

As the new index will use the same formula as the CPI for calculating average prices, RPIJ will usually rise more slowly than the long established RPI.

Ros Altmann, the director general of the financial services company Saga and a former government adviser on pensions policy, hailed the ONS decision as "brilliant".

Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), said: "Pension funds are relieved that RPI has been left intact because rewiring this crucial measure would have created upheaval for both inflation-linked pension fund investments, and the income of current and future pensioners.

Inflation measures explained

  • CPI: Based on the prices of a basket of goods. First used in the UK in 1996, it is now the government's preferred measure when uprating benefits and the state pension
  • CPIH: Similar to CPI, but will include the changing level of housing costs for home owners, such as mortgage interest and buildings insurance
  • RPI: Usually rises faster than CPI. Unlike CPI, it excludes the spending of the wealthy and pensioner households mainly dependent on the state pension and benefits - some 13% of the population. Also has a different mathematical formula to calculate the average rise in prices
  • RPIJ: A new version of the RPI index but using the same methods as CPI for calculating average prices

"Reworking RPI would have given many pension funds some much-needed breathing space by reducing their liabilities, but it would also have cut the growth in pensions paid to former workers.

"A pensioner with an average RPI-linked final salary pension of £7,600 could have seen a £20,000 fall in their income over a 20-year retirement," she explained.

The Royal Statistical Society warned that devising a new index was not necessarily the best solution.

"The formula effect generally, and particularly in the case of clothing, is dependent not just on the choice of index but also on the characteristics of the price movements and levels being measured, sample design, choice of base period and price collection methods," said its spokeswoman Jill Leyland.

"Simply replacing the arithmetic Carli formula with the geometric Jevons formula, as will happen in RPIJ, is not optimal," she added.

Housing costs

The Treasury confirmed it would continue using the RPI measure for calculating the return on both old and new index-linked bonds.

"For gilt investors, future cash flows on existing index-linked gilts will continue to be calculated by reference to RPI," said the Economic Secretary, Sajid Javid.

"The government will continue to issue new index-linked gilts linked to the RPI."

The ONS has already decided to launch another new measure of inflation in March, to be called CPIH.

This will be a version of the current CPI index, but adjusted to measure changes in the cost of buying and owning a home.

The main CPI measure excludes those costs, something which has long been seen as its major flaw.

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