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UK Inflation: Mind the Gap
• Recent changes in the inflation measure
used to index benefits and pensions have
attracted attention to the difference between CPI
and RPI inflation.
Chart 1: Contributions to CPI-RPI Difference
• We examine here exactly what drives the
difference between CPI and RPI inflation and
how the gap is likely to evolve.
• We expect the gap to narrow temporarily
over the coming year, before widening sharply
during 2012 when Bank Rate begins to rise.
The switch in the gauge of inflation that is used to
benchmark private sector pension schemes has
generated considerable attention in the differences
between CPI and RPI inflation. The move, intended
to boost consistency, follows the announcement in
the Emergency Budget that public sector pensions
and benefits will now rise in line with CPI inflation
rather than RPI inflation. Given this, we have
provided a guide to what the differences in the two
indices are and secondly, how we expect the gap
between the two to evolve.
Difference between CPI and RPI
The CPI and RPI are compiled using the same
underlying price data. However, there are a number
of differences:
• The CPI excludes a number of RPI series, in
particular, council tax, mortgage interest
payments, housing depreciation and
buildings insurance;
• The CPI includes a number of series that are
not included in the RPI. In particular,
university accommodation fees, foreign
students’ university fees and stockbrokers’
charges;
• The weights applied to some components of
the CPI are a little different from the weights
applied to the equivalent component of the
RPI; and
• The CPI uses the geometric mean to
combine the individual prices while the RPI
uses the arithmetic mean.
Note that RPIX is the RPI excluding mortgage
interest payments.
Source: Reuters EcoWin Pro, BNP Paribas
Recent developments in the CPI-RPI differential
The experience of the last 18 months provides a very
good illustration of what typically determines the
differential between CPI and RPI inflation.
By far the biggest difference between CPI and RPI
inflation is the inclusion of housing related
components in the RPI but not the CPI (Chart 1). In
turn, mortgage interest payments (MIPs) and house
price inflation tend to be the biggest contributors.
By way of example, the gap between CPI and RPI
inflation exploded to over 3 percentage points during
2009. RPI inflation plunged to a low-point of
-1.6% y/y while CPI inflation only slowed to 1.1%.
RPI inflation slumped owing to a combination of
falling house prices and interest rate cuts. More
specifically, the BoE slashed Bank Rate from 5.75%
to 0.5%. This caused the MIPs component to plunge
by 45% y/y. Given a weight of around 5% in the RPI
index, that subtracted over 2pp from RPI inflation.
Similarly, the house price inflation component of the
RPI slumped to a low point of -13% y/y. With a
weight of 5% in the index, that subtracted over 0.5pp
from headline RPI inflation.
Over the last year the differential has reversed i.e.
RPI inflation has gone from around 3pp below CPI
inflation, to 2pp above CPI inflation. The bulk of that
change has reflected an unwinding of the influences
that provoked last year’s undershoot. More
specifically, since mortgage rates are no longer
falling, the near 45% y/y decline in the MIPs
component has recovered to +5%. That 50pp move
in itself has added almost 2.5pp to RPI inflation since
the trough. Likewise, house price inflation has
Alan Clarke 16 July 2010
Market Mover
10
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