Last week it was announced that UK Rail Fares were to increase once again at the maximum allowed rate - 3.4%, corresponding to the RPI increase in July 2017.
When reading this it got me thinking - why is RPI even being used any more? Aren't we supposed to be using CPI now?
In 2013 the ONS stated that:
"Following a consultation on options for improving the Retail Prices Index (RPI), the National Statistician, Jil Matheson, has concluded that the formula used to produce the RPI does not meet international standards and recommended that a new index be published."
So basically the ONS no longer endorses RPI as the best indicator of the level of inflation in the economy. The ONS instead supports the use of CPI. So why does it matter that some organisations are still using RPI? To see why, let's take a look at a chart showing the historic RPI and CPI increases in the UK:
RPI has been greater than CPI in every single month since 2010. In fact, in this time period, RPI has been an average of 0.8% higher than CPI. This fact might go some way to explain why the Government is so slow to move rail increases from RPI to CPI. This way the Government and Rail Companies can claim that they are only increasing their costs in line with inflation, which seems fair, yet the index they are using is actually higher than the usual inflation index used in the UK.
The Government also indexes some of it's outgoings by an inflation index, for example the State Pension, so at least this is also being consistently overstated right?
Well actually no! Wherever the government is using an inflation index to increase payments, it seems to have already transitioned to a CPI increase. Let's look at the list of items which use the inflation index which is more beneficial to the Government: (remember that CPI is almost always lower than RPI):
There are some pretty hefty items on the list, including, the State Pension, Benefit Payments, Rail Fares, Utility bills, Student Loans. The ones that decrease government spending seem to have already transitioned over, and the ones that increase the amount of tax collected, or the cost of regulated items all seem to still be using the higher RPI index.
Now let's look at the list of items which use the inflation index which is to the disadvantage of the Government.
The list is certainly a lot shorter, and the items on it are less substantial. Indexed linked Government Bonds are however quite substantial. The reason that the Government is not able to move these to a CPI index is that it would be considered a default to downgrade the index once the bonds have been sold. The Government has no choice but to continue paying the bonds at RPI. Also, the yield on the bonds will be set with an eye towards the yield on a fixed bond, and the expected level of inflation. Therefore the actual index used is not necessarily that important.
It's nice to see though that at least stamps are increased at a CPI rate!
I work as an actuary and underwriter at a global reinsurer in London.