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RPI inflation formula to remain unchanged following consultation

The inflation formula used to uprate private sector pensions and index-linked bonds will remain unchanged, the Office of National Statistics (ONS) has announced.10 Jan 2013

The announcement follows a three-month consultation on potential changes to the way the Retail Prices Index (RPI) rate is calculated. The changes were being considered to bring the RPI into line with the other common measure of inflation, the Consumer Prices Index (CPI), which is used to uprate public sector pensions and state benefits.

The ONS will instead begin to publish an additional RPI index, calculated using a different formula, alongside the existing one from March.

Jil Matheson, the National Statistician, concluded that the formula used to produce the rate, known as the 'Carli' index formula, did not "meet international standards". However, she added that there was "significant value to users" in "maintaining continuity" on long-term indexation, index-linked gilts and bonds.

"While the arithmetic formulation would not be chosen were ONS constructing a new price index, the National Statistician recommended that the formulae used at the elementary aggregate level in the RPI should remain unchanged," the department said.

The different methods used to calculate RPI and CPI have resulted in an artificial difference, known as the 'formula effect gap', which has led to CPI rising more slowly than RPI. The formula for calculating CPI considers the spending behaviour of people who might switch to cheaper alternatives as prices increase including pensioners, foreign visitors to the UK and students in halls of residence. RPI, on the other hand, excludes the top 4% of households by income and low-income households, such as those of pensioners or people on state benefits.

CPI does not include changes to the cost of housing, such as the value of mortgage interest payments, house depreciation and council tax. However, the ONS intends to begin publishing a new version of CPI from March which will take these costs into account.

Pensions expert Mark Baker of Pinsent Masons, the law firm behind, said that the decision was an "important and welcome boost" for pensions savers although some businesses might be disappointed.

"This week we have seen the coalition government playing a difficult balancing act between wanting to look after pensioners, and being realistic about the future cost of doing that - so the last thing anyone wanted was another blow to public confidence in pensions," he said.

"Businesses with pension schemes will have mixed feelings. A change to the RPI calculation would have cut many of their liabilities, so some businesses might be disappointed. But most companies will be paying off their pension costs for many years to come, so it is important that they have faith in the longer-term predictability of RPI."

Commercial property law expert Suzanne Gill of Pinsent Masons said that the decision not to do away with RPI altogether, one of the options that had been considered by the consultation, would come as a relief to landlords and tenants.

"Many leases have rents which are linked to RPI and so the decision by the ONS not to abolish it will be a relief for landlords and tenants where their lease is silent on what happens if RPI is abolished," she said. "However, given the ONS recognises that RPI no longer reflects inflation in the modern world, the decision to continue to publish it will simply perpetuate the problem."

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