UK to replace RPI with CPIH as a measure of inflation from 2030

Summary

• The UK government and UK Statistics Authority have made a joint declaration on 25 November that the Retail Price index (RPI) will get replaced by the Consumer Price Index including Owners Occupiers housing cost (CPIH). 

• The change, however, will not take place before 2030.

• The change in methodology will impact several index linked pension schemes and interest linked Gilt edged securities in the UK.  

Britain has finally decided to bring in a major reform in its financial system. It has been decided that the Retail Price Index, an inflation measure that has been in use in the country since 1947, will finally be replaced with the Consumer Price Index, including owner occupiers’ housing cost (CPIH) from 2030. 

At present, RPI is used extensively in the UK for measuring the price level by both the government and the industry and is widely considered as inferior to Consumer Price Index (CPI), which is a preferred inflation measure in most developed countries. 

This change will have a major impact on the government, industry and the taxpayers. The government will be benefited as the inflation adjusted interest rates of government debt are likely to be lower under CPIH than RPI. But inflation adjusted pension earnings are likely to be lower under the new measure, spelling bad news for the retired class.  

The move will bring the British economy at par with the rest of the world, in terms of a less volatile nominal interest rates. Such a structure would also lead to a reduction in the overall cost of doing business, benefiting the industry. 

RPI drawbacks

Among RPI, CPI, and CPIH, RPI is the most volatile measure of price changes. The use of house prices and interest rates in its calculation makes it distorted as it does not consider a rental equivalent for house owners. 

Since 2013, RPI has not been classed as an official statistic. And as per the calculations, it has a flaw which causes it to be around 0.8 percentage points higher than it should be. 

Secondly, it uses another faulty measure called house depreciation, which is not accurate conceptually. While it is common that the value of real estate only goes up over time, pegging the renovation and upkeep expenses of the property to its cost is also fundamentally wrong, according to John Pullinger, National Statistician, the Office for National Statistics. 

These and several other minor flaws in the methodology of calculating RPI that make it present an inflated picture of the price trends as compared to the CPI and CPIH.  

The choice between CPI and CPIH

The government has chosen CPIH as its measure of inflation over CPI as it reflects the effects of housing costs on the consumer cost of living better than the latter one. 

In most of the developed world CPI is a preferred measure as it uses a select basket of goods and services to gauge the effect of changing prices on people. 

However, for a country like Britain which has land scarcity and is an important business destination in the world, rent forms an important part of cost of living for its inhabitants. Thus, Consumer Price Index including owner occupiers’ housing cost or CPIH is more suitable for the nation which should be used for all inflation related data.  

Gilt-edged securities

The British government issues long term securities which are pegged to the RPI. While it was known that the usage of this index made the cost of these debts more expensive for the government, its adverse effects were felt this year after the pandemic outbreak.  

This made the government rethink on the RPI and move towards an inflation index that is in line with the global practice.  After 2030 when the change takes place, decreasing the cost of debt will help the government borrow more for the same amount of interest outgo and use it for the economy’s growth. 

Pension schemes

Ten years down the line, the pension receivers of the country are, however, in for an ordeal with the implementation of the CPIH. Since CPIH is expected to show a slower rise in inflation, the future pension pays are likely to be lower as compared to the RPI based calculations. 

There are a large number of pensioners in the UK, deriving pension from either from the government, the private companies or pension providing firms. Once the pension payout goes down, it will have an impact on the spending behavior of a large section of the population.  

Finally, the adoption of the inflation index from RPI to CPIH may not be as tough as it may initially appear. Firstly, people have 10 long years to adjust to the new system. 

Secondly, a new system will lead to a general lowering of cost of doing business in the country. This will lead to economic growth and employment generation. Therefore, the net benefits of using CPIH would be higher than the anticipated losses.