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New decade moves us closer to the reform of the RPI inflation measure


Charities Team

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The new year and decade will bring us closer to a step we believe necessary and inevitable: that the historic RPI measure of inflation be replaced with the more effective Consumer Price Inflation (CPI).

Next month – January 2020 – the Government will launch consultation on reforming or discontinuing the long-standing RPI measure. It has promised to publish a response by the Spring Statement in March 2020.

This is a welcome move, as we believe RPI a less effective  measure of price increases. Firstly, it is no longer the accepted national standard measure of inflation – having been replaced by CPI, which is generally seen as a more accurate economy-wide measure. Secondly, the underlying formula for calculating RPI is flawed and leads to a long-term upward bias.

Background: RPI vs CPI

When the Bank of England’s Monetary Policy Committee was established in 1998, it used RPIX (RPI excluding mortgage payments) as the target measure of inflation. But CPI replaced this as the official target in January 2004.

In recent years CPI has increasingly become the standard measure of inflation across the investment industry. RPI data continues to be generated because of the needs of users who have long term contracts linked to it, as well as for index linked government bonds, but it is increasingly a “legacy calculation”.

Steps taken in 2019

An enquiry by the House of Lords in January 2019 concluded that RPI is not an appropriate measure for UK inflation, and called for the UK Statistics Authority (UKSA) to pursue a programme of improvements.

After much delay, on 4 September 2019 the UKSA and the Chancellor of the Exchequer published a co-ordinated set of responses to the House of Lords’ enquiry.

The UKSA’s recommendations were clear. The body said that:

  • publication of RPI should cease (recognising this needed primary legislation and would have significant market impact), and, if this not acceptable, that
  • changes should be made to RPI to align it with consumer prices inflation, including owner-occupiers’ housing costs (as captured in the CPIH measure).

The Chancellor’s response however rebuffed the UKSA’s recommendation to abolish RPI. In its response it:

  • reaffirmed that the Chancellor needed to sign-off changes to RPI before 2030
  • recognised the disruption that changes to RPI may cause, in particular to holders of index-linked gilts
  • proposed that changes to RPI should not occur before February 2025
  • said it would consult on changes in January 2020, promising to publish a response by the time of the Spring Statement
  • confirmed that the Government will continue to issue RPI-linked gilts.

Legally no changes were made to the current approach to constructing RPI inflation. However, it seemed that the Chancellor was allowing the UKSA to align RPI’ s calculation with CPIH from 2030, if it so wished.

Given that the UKSA has now made clear its ambition to do this, it seems significantly more likely that RPI will change materially at some point in the next ten years.

Structural differences between RPI and CPI – and how markets might react in future

Statistically, over the long-term, the structural difference between RPI and CPI is around 0.8% per year.  Following the September announcements, market expectations of RPI beyond 2030 fell by around 0.2%. Nearer-term expectations ahead of 2030 were largely unchanged

The market seems to be pricing in a long-term difference between RPI and CPI of around 0.4% a year, suggesting that the market has yet to fully price in RPI’s alignment to CPIH. This seems fair as there is still material political uncertainty in the UK around the will of future governments to see RPI changed to the detriment of both index-linked gilt holders and pensioners.

Cazenove Charities’ view

We believe that CPI is better than RPI as a measure of the true inflation in the economy.

We recognise that defining what might be considered the “true” rate of inflation is difficult as the basket of goods that might be representative for one social group or age group may not be appropriate to another. It is also the case that inflation rates for charity expenditure also varies. However, assuming that asset returns are based on economy-wide inflation, we believe it is appropriate to use a measure of prices that most closely reflects the wider economy, whilst also being the accepted national standard.

We recommend using CPI as the relevant inflation index for our charity investment mandates. It is also the inflation reference index we use for our Charity Multi-Asset Fund and our Charity Responsible Multi-Asset Fund.

The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Registered Office at 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored. 

Contact Cazenove Charities

Achieving your charity's investment objectives takes time and thought. To find out how we can help you please contact:

Kate Rogers

Kate Rogers

Co-head of Charities kate.rogers@cazenovecapital.com
Alex Baily

Alex Baily

Co-head of Charities alex.baily@cazenovecapital.com