The retail prices index (RPI) measure of inflation will be brought in line with the UK’s official CPIH rate by 2030, the Treasury has confirmed. Will you be better or worse off after the change?
RPI is widely used to calculate interest payments on index-linked bonds and student loans, as well as annual increases on some pensions, rail fares. mobile bills and taxes. However, it has been widely discredited by British statisticians since 2013, on the grounds that it typically overstates inflation.
Alongside the Spending Review on 25 November, Chancellor Rishi Sunak confirmed the move to bring the rate in line with the ‘Consumer Prices Index with owner occupier’s housing costs’- or CPIH for short – which takes into account the cost of housing. This measure of inflation is typically 0.8 percentage points lower than RPI.
The move could cost investors and pensioners hundreds of billions of pounds, but leave rail passengers and student loan borrowers better off. Which? explains what the changes mean for your finances.
Why measuring inflation is important
Inflation gives us an idea of how much prices have changed over a 12-month period and is used to determine how things like benefits and bills need to change to keep up.
As it stands, there are three main ways of measuring inflation: the RPI, CPI, and CPIH.
All measure inflation by looking at the changing prices of around 700 everyday goods and services, but they include different items, cover different parts of the population and are calculated in different ways.
For example, RPI measures the changing prices of a basket of goods and services, including mortgages and interest payments. CPI doesn’t take housing costs into account, so CPIH was introduced to address this gap in 2017.
- Find out more: October inflation jump – what it means for your money
What’s the problem with RPI?
The problem with RPI was brought into focus in 2010, when the range of clothing in the basket of goods used to calculate RPI was expanded to make it more comparable through the seasons.
As a result, there was a spike in clothes price inflation that the Office for National Statistics (ONS) has called ‘implausible’. It comes down to how RPI averages things out, which tends to exaggerate rises, investment and pensions provider Hargreaves Lansdown explains.
This ‘flaw’ causes RPI to be about 0.8 percentage points higher than it should be. For example, last month’s CPIH was 0.9% while RPI stood at 1.3%.
The chart below shows you how RPI and CPIH have compared over the past decade – the ONS has calculated rates back to 1989.
RPI has been dropped as an official inflation measure by the ONS, and is just kept as a legacy measure because so many things are linked to it throughout the economy like defined benefit (DB) pensions.
Who’s likely to lose out as a result of the reform?
The Association of British Insurers estimates that the move could cost investors and pensioners £122bn.
The cut is likely to slash the returns paid to investors in index-linked bonds, which include some pension funds, meaning any pensioners with an RPI-linked income will see incomes rise more slowly.
However, the government has confirmed that it will not offer compensation to the holders of index-linked gilts for the watering down of their investments.
The table below outlines how people could be affected in more detail.
| Final salary pension scheme members | Nearly two-thirds of private-sector DB schemes link rises in pension income directly to RPI. So switching to a lower measure of RPI could mean lower future incomes in retirement. This doesn’t just affect today’s retirees, but millions of workers paying into these schemes too. |
| Annuity holders with RPI guarantees | If you bought an index-linked annuity, changes to the index are likely to see your retirement income rise more slowly. |
| Bond investors | If you have index-linked bonds, or ‘gilts’ in your investment portfolio, the change will mean lower index-linking (assuming your bonds are linked to RPI). Their value is also likely to fall, as investors see them as less attractive. |
Source: Hargreaves Lansdown
- Find out more: check out our pensions and investment guides
Who will be better off from the change?
It’s not all bad news for your finances.
For the products and services that are currently pegged to RPI, prices will go up more slowly once it’s in line with the lower CPIH.
We’ve outlined these in the table below:
| Rail fare prices | Yearly rises in regulated rail fairs, which includes season tickets, are capped using RPI. |
| Mobile phone tariffs | Most mobile phone companies use RPI to calculate annual increases to your bill. |
| Car tax | Vehicle excise duty is linked to RPI. |
| Air passenger duty | This tax is paid by travellers so a lower rate will mean savings on holidays. |
| Tobacco and alcohol | These prices rises are linked to RPI and are normally increased each year in the Budget. |
| Interest on student loans | People who have Plan 1 student loans (those who started university between 1998 and 2011 and Scottish and Northern Irish students starting after 2012) are charged interest at either RPI or the base rate plus 1%, whichever is lower. Plan 2 student loans (for those who started university in or after 2012) are charged interest at RPI plus up to 3% depending on income. |
Why is RPI changing in 2030 and not now?
The government has been consulting on whether to bring RPI in line with CPIH since the March Budget.
It had been considering implementing the changes from 2025, but the Chancellor has delayed it to limit the impact on RPI-bond holders.
In 2030, the final set of index-linked gilts with an RPI promise will mature.
What other changes were announced in the Spending Review?
The Chancellor put the government’s response to the coronavirus crisis at the centre of his speech, noting a further £55bn investment on top of the £280bn injected so far this year.
He also introduced additional measures for income and job protection, including help for lower-paid workers and public sector staff.
Sunak also said he’d strengthen public services by providing new hospitals, better schools and safer streets, and announced plans for £100bn in capital spending for infrastructure projects.
To see the spending plans for the next financial year in more detail, check out our coverage of the review.
source https://www.which.co.uk/news/2020/11/rpi-inflation-reform-what-it-means-for-pensions-student-loans-rail-fares-and-more/