After an extended period of exceptionally low inflation and low interest rates, Inflation is on the rise and interest rates seem set to rise, albeit slowly, in response on both sides of the Atlantic. But inflation affects different people in different ways, and there are several alternative ways in which inflation is measured.
The Retail Prices Index (‘RPI’) was created in 1947, when the typical shopping basket consisted of items we barely recognise today: rabbit meat, cod liver oil, tinned salmon, lamp oil, condensed milk and men’s and women’s hats.
Reflecting the very different lifestyles of today, these items are no longer included among the 700 items whose prices are now measured by the Office for National Statistics to calculate RPI, the latest additions to which include gin and non-dairy ‘milk’ drinks.
A second inflation index, the Consumer Prices Index (‘CPI’) was introduced in This comprised a different basket of consumables from the RPI and excluded mortgage interest payments. CPI is on average 1.2% lower than RPI, and has been adopted by the government to calculate welfare payments and pensions, thus reducing the burden of these expenditures on the State.
The Royal Statistical Society has calculated that the adoption by the government of CPI rather than RPI in calculating public service pensions will reduce their value by £30,000 over 25 years, assuming RPI of 3% and CPI of 2.33%
The Chancellor announced in his November Budget that CPI will in future also be used to peg business rates and to determine annual investment limits for junior ISAs and trust funds, the capital gains tax exemption and the lifetime pension savings allowance, which will rise to £1,030,000 for 2018/19. However, RPI is still used in determining rail fares, alcohol, student loans and index-linked gilts (government bonds).
To further complicate the issue, the government has now created a variant of CPI called CPIH (H for Housing). This includes the cost of renting a home but not the average mortgage payment. Consequently, it does not reflect variations in house prices. These are dealt with in yet another index.
People’s age, location and food preferences will all affect the impact of inflation. Pensioners will be affected disproportionately by increases in food and energy costs, and they are consequently less well served by CPI. People living in rural communities, on the other hand, will be more affected by the price of fuel, which is included in the RPI.
Most people will have little idea of which index relates most closely to their lifestyle, but it is the government which is best placed to play the system in what it regards as the national interest.