On 25th November, Chancellor Rishi Sunak announced that the UK will stop using the retail price index (RPI) as of 2030. The RPI is an inflation measure that on average reads 1% higher than the UK’s official inflation measure, the consumer price index adjusted to include housing cost (CPIH). This decision is set to impact a diverse range of stakeholders, yet it remains difficult to accurately quantify and predict their reactions given the remaining 10-year life span of RPI.
Despite losing its status as a national statistic in 2013, the RPI was still reported by the Office for National Statistics (ONS) because it is embedded in the UK bond market – government-issued gilts pay interest adjusted inline with RPI. Crucially, a number of flaws exist, some of which include: reading 1% higher on average than the UK’s official measure of inflation; being sensitive to relatively volatile house price indices; and using the flawed Carli formula (its upwards bias is one of the reasons that it is not used in any other advanced economy around the world). The ONS concluded in a 2012 consultation that ‘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 in accordance with user expectations’. Now that the RPI is being removed, RPI-linked contracts will switch to the CPIH instead.
The change is most likely to benefit the taxpayer and government, whilst negatively impacting savers and pensioners. The Treasury is predicted by the Office for Budget Responsibility to save around 2 billion GBP. Meanwhile the Association of British Insurers estimates savers and pensioners will lose out by 122 billion GBP. This is because pension funds tend to hold RPI-linked bonds, thus reductions in the inflation rate of future interest payouts reduces the bonds’ values. Similarly, two thirds of private sector defined benefit pension schemes link pension incomes to RPI. Therefore, a switch to CPIH, which reads about 1% lower than RPI on average, will reduce future pension payouts. Calls for compensation being provided to bondholders, given the reduction in value of their assets, have been ignored. The Chancellor stated that holders of RPI-linked gilts will not be compensated for their lower interest payments.
Stakeholders set to gain from the change are varied, they include rail ticket purchasers who can expect smaller price rises in the future; those with student loan repayments who may see their interest repayments increase at a slower rate; and mobile phone users with RPI-linked contracts who may also expect smaller price rises in future. In essence, anyone making RPI-linked payments may be set to gain as product and service providers switch to the lower CPIH metric. Indeed, future price increases will likely be at a lower rate using CPIH versus RPI, thus consumers pay less. It is currently unknown whether any providers will opt to estimate RPI. For example, a crude version could be CPIH +1%, to sustain their historical price increases.
In conclusion, this change in the measure of inflation is likely to have diverse and far-reaching impacts across the UK. Whilst naturally benefiting some and being detrimental to others, accurate quantifications of the impact are difficult to estimate 10 years into the future. Potentially of most interest will be assessing the relevant parties’ responses to the changes. However, given that they have 10 years to address them, updates in the short-term may be limited.
By David Bendle
Sector Head: James Float