How much could it cost to say R.I.P to RPI?

by , Money Editor Money 4 December 2012
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The Office for National Statistics could be the new wicked witch of personal finance if its proposed changes to the way inflation is measured go through. Would a change in RPI affect your finances?

Gravestone with RIP engraved on the front

It’s not often that number crunchers make the front pages. But over the next few weeks, the Office of National Statistics (ONS) may come under the spotlight by recommending a small change to the way inflation is calculated. The change could leave thousands of UK savers, investors, pensioners and benefit claimants out of pocket.

The Retail Prices Index (RPI) is one of the two main measures of UK inflation – the other being the Consumer Prices Index (CPI). You can tell how quickly the cost of goods and services is rising or falling by seeing how much these two price indexes change.

Why not wave goodbye to RPI?

Due to the differences in the way CPI and RPI are calculated – RPI has historically always been higher than CPI. In fact, it’s been an average of 0.9 percentage points higher, and the government’s Office for Budget Responsibility predicts this will widen even further in the future, to around 1.5 percentage points.

But the Office of National Statistics is considering changing the way it calculates RPI to bring it closer to CPI – a move which would cost some thousands. If, for example, CPI rose by an average of 2% a year, and RPI rose by 3.5% a year, someone who retired today with a pension of £30,000 a year rising in line with RPI would have an income of £84,203 in 30 years time. Yet if their pension was linked to CPI, it’d only be worth £54,340.

Innovation to change inflation

Considering that a reduction in RPI saves the government billions of pounds, it’s not hard to see why it might welcome moving the two measurements closer together. In fact, the government has already taken the unpopular step of changing the link for public sector pensions and state benefits from RPI to CPI.

In reality, I don’t think any measures of inflation are particularly useful – each person’s cost of living moves at different rates. How hard could it be to come up with multiple measures of inflation that reflect people’s life stages, rather than using averages for the whole nation?

The ONS is still to decide whether to recommend the change – but if it did, would it have a detrimental effect on your finances? Are any of your current financial products already linked to RPI? Have you bought a product linked to RPI in the past few months?

5 comments

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rarrar

Never thought that RPI or CPI reflected my own personal inflation rate, but having locked away money in saving schemes linked to RPI I do not expect the way it is calculated to be radically changed. Changing the “shopping basket” used in the calculation is perfectly acceptable.
Part of my public sector pension is based on extra voluntary contributions and the information provided when I made these said RPI was used for inflation proofing – this has now been changed to CPI .

For newly sold products, benefits and state pensions radically changing the way RPI is calculated is probably defensible, but for existing products an index based on the existing RPI needs to be created and maintained.

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Malcolm R

Religiously increasing salaries, wages, benefits and pensions each year by at least inflation simply creates more inflation – more taxes to fund the pensions and public sector salaries, higher prices to fund the private sector wage bill. So next year we add more to combat this rise in costs that we have created. Can you break this spiral? Perhaps a one year freeze on all these payments might help. The remaining inflationary element would then be from costs that we can’t control – so maybe the rpi / cpi could be contained at a lower level. Until we enter the next boom and bust era of course.

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b.martin

One should remember that the CPI is an EU inspired index which took no account of the British economy and as such should not be adopted. Like most EU directives it suffers from serious flaws and should be discarded. The RPI is a better measure of inflation in the UK.

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Denis

Leave RPI alone. There are too many financial implications, funds and pensions linked to it. Any alternative will be no better and probably worse knowing the ONS. The CPI is unsuitable for the UK as some other comments state. A change in the RPI is only wanted by the government to reduce expenditure on pensions etc.

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Denis

The proposal to replace the arithmetic average to adjust the weighting of values in the RPI by the geometric average used in the CPI will certainly reduce the RPI. The weighting concept used in either index is dubious (a fudge), being just a compromise. The geometric average would no doubt appeal to the ONS statisticians as being more sophisticated but has few advantages over the arithmetic average which is much simpler. The most important characteristic of an index is its consistency over time and changing the method will just confuse comparisons.
Some time ago there was a proposal, coming from the EU, to adjust the CPI to allow an element of mortgages in that index. The recession seems to have put a stop to this.

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