CPI vs RPI inflation

Everywhere you look, prices are rising. The measure of how fast and high those prices are going up over a certain period of time is called inflation. Confusingly, there is more than one way to calculate inflation.

Here we focus on the two most common: the Consumer Price Index CPI and the Retail Price Index RPI. But what is the difference between them and why does it matter to our money?

What is inflation?

Inflation is the rate at which the goods and services in an economy are going up in price over a set period of time. In the UK it’s calculated by the Office for National Statistics (ONS), with the figures released every month showing the previous month’s inflation.

The official headline rate shows, on average, what we buy has gone up by that amount compared to the same time last year. However, we all have different spending habits and so our own personal inflation figure (the increase in price of things that we commonly buy as individuals) is unlikely to match that reported by the ONS. You can use the ONS personal inflation calculator to work out how much extra you’re paying.

If your income or savings rate doesn’t keep up with the pace of inflation, then your money will effectively be able to buy less than it could before, thereby decreasing your spending power.

How do we measure inflation?

The ONS can’t calculate the change in price of every single item or service that we can buy. Instead, it uses a representative shopping basket into which it puts 743 items and monitors around 180,000 prices and works out the average rise across all the values. A simple calculation clearly.

The items change each year to reflect our evolving shopping habits. Back in 2000, for example, Walkmans, VHS videos and rollerblades were all used to measure inflation. Today, those items are nowhere to be found. Instead, you will see e-bikes, security cameras and frozen berries included in the basket.

The UK uses several measurements of inflation that all differ slightly in their calculations and what is put into the shopping basket. These include:

• CPI: the consumer prices index
• CPIH: the consumer prices index plus owner-occupiers’ housing costs
• RPI: the retail prices index

Below we explain the difference between the main two indices: CPI and RPI.

What is the difference between CPI and RPI?

CPI and RPI both aim to measure the cost of living and how it is increasing over time. The key differences between the two is the goods and services that are included in their shopping baskets, the representative population they cover, and how they are calculated.

RPI uses an arithmetic mean based on adding up all the values and dividing them by the number of values. This is the most commonly used type of mean.

CPI is more complicated and uses a geometric mean which multiplies and finds the root of values. It’s considered the more statistically accurate of the two measures. Fancy stuff.

RPI and CPI are also used for different purposes in the UK economy (even though RPI is not an official measure).

What is CPI?

The Consumer Prices Index or CPI was introduced in 1996 to measure inflation consistently across all EU members. It replaced the RPI in 2003 as the statistical measure of inflation in the UK and is what the Bank of England (BoE) uses to set its 2% target. At the moment, CPI is currently much higher and has been above target for the last two years.

CPI is calculated by measuring the price of items that we regularly spend money on, excluding housing costs such as mortgage interest payments, council tax, and private and social rent. Increases to the state pension and other benefits each year are linked to CPI.

What is RPI?

The Retail Price Index or RPI was first introduced in 1947 and became the official measure of inflation by the UK government in 1956. Unlike CPI, RPI includes housing costs. RPI was replaced in 2011 by CPI for calculating increases in social security payments and the state pension and by 2013 it was held not to be compliant with international standards.

The ONS lists the RPI as “not a national statistic”, however it’s still calculated each month and used to judge the UK economy. It’s linked with a number of annual price rises, including:

• Regulated rail fares
• Car tax
• Mobile phone tariffs
• Alcohol and tobacco duty
• Student loan interest
• Final salary pension payments
• Income from index-linked annuities

Why is RPI inflation higher than CPI?

The monthly UK inflation figure is generally higher when RPI is used compared to CPI because of the way the indices are compiled and calculated. RPI, unlike CPI, includes housing costs such as mortgage interest payments and rent. As a result, it tends to overstate inflation, especially when house prices and interest rates increase rapidly.

Another reason for the difference is that the formula used to calculate RPI tends to produce higher results. RPI also measures the average household in the UK, while CPI also covers institutional households, which includes student accommodation and care homes, which can increase the figure.

What happens when inflation falls?

When inflation falls, prices are still rising but at a slower rate. For example, if CPI was down from 10.1% the previous month to 8.7%. That means that prices are still going up, but by a smaller amount.

When prices keep falling below zero percent inflation rate, it is called deflation and this is considered bad for an economy. As prices drop, consumers start to anticipate further falls in prices in the future and so delay making purchases.

Deflation tends to lead to less economic activity, lower income generated by businesses meaning less cash to invest and pay their staff and lower economic growth. This scenario could potentially result in recession or depression and job losses.

What happens when inflation rises?

When inflation rises, the value of the money that we have now won’t buy us as much in the future. For example, ten years ago you could buy a loaf of white bread for 47p. Now the same loaf will set you back £1.37, meaning you could only afford a third of it.

Inflation has a devastating effect on your savings. Recently savings rates have started to climb, but they are still below the rate of inflation.

Let’s say inflation averages 5% over the next 10 years, this is how the buying power of £1000 would change over time:

• In 1 year – £926
• In 5 years – £681
• In 10 years – £463

If you put £1,000 in a savings account today paying 2.5% interest, you’ll earn £283.69 interest over the same period. So you’d effectively lose £253.31.

Why do I need to understand the difference between CPI and RPI?

You might wonder why you need to understand the difference between CPI and RPI, afterall, high inflation is bad whichever way you measure it. However the two indices are linked to different things in the UK economy that could have a serious impact on our finances.

The government is planning to ditch the RPI measure by 2030 to bring it closer to CPI, which has been around 1% lower over the last two decades. This would potentially be good news for things like rail fares and student loans that currently go up each year linked to RPI. It would spell bad news for those with private pensions and annuities that come with RPI guarantees.

Is inflation good or bad?

A little bit of inflation is considered good for an economy as it can drive growth and provide companies with money to invest in their business and pay their employees more. The BoE sets an inflation target of 2%.

If inflation is high, your income won’t be able to stretch as far and your standard of living falls. This can have serious implications on your day-to-day budgeting as well as your savings. Over the long-term, inflation can have a big financial impact.

In an effort to bring down inflation, the BoE will raise interest rates, which can substantially add to millions of people’s mortgage repayments.

Is CPI or RPI a better measure to use?

CPI is considered the more reliable measure of inflation. The problem with RPI emerged around 2010 when the range of clothing in the basket of goods used to calculate it was expanded to make it more comparable through the seasons. “As a result, there was a spike in inflation that the ONS called ‘implausible’” says Sarah Coles, Personal Finance expert at Hargreaves Lansdown. “It comes down to how RPI averages things out, which tends to exaggerate rises.”

RPI excludes the top 4% of households by income and some of the poorest pensioner households, namely those that are mainly dependent on state benefits, according to the ONS. This means that the spending patterns of around 12% of households are excluded from the total calculation.

RPI lost its classification as a ‘national statistic’ in 2013 although it is kept as a legacy measure because things are linked to it throughout the economy. From 2030, the government will stop using RPI as a measure of inflation and instead will use the CPIH measure, which includes owner-occupied housing costs.

How changing RPI could affect your annuity

An inflation-linked annuity rises each year in line with RPI to protect your retirement income against the effects of inflation. If RPI is changed, as is expected from February 2030, this will have a significant impact on annuities which could leave pensioners worse off.

Owners of index-linked government bonds will find the inflation rate linked to their investments will change. Between 2000 to 2020, CPIH inflation has been 0.9% lower on average than RPI. According to SharingPensions, a single male aged 65 with a fund of £100,000 could purchase an RPI escalating annuity with an income of £3,500 pa.

If RPI was expected to be 1.0% less than expected on average in the long term, the income paid to the pensioner would be £8,175 lower.

How can I protect my finances from inflation?

Unfortunately we can’t lower prices but there are steps you can take to mitigate the effect of inflation on your money.

1. Check your savings rate. If you are in a fortunate position to be able to save, BoE rate rises can been good for savers. While you won’t find an account that always beats inflation, shop around and you will find the top paying accounts pay decent interest. If you’re happy to lock your money away for a year, you could earn even higher interest.

   E.g. £15,000 in a savings account, annual interest:

   • 0.19% = £28.50
   • 2.36% = £354.00
   • 4.25% = £637.50
   • 6% = £900
2. Consider investing. If you are willing to tie your money up for a minimum of five years or more, then you might want to consider investing. While there is no guarantee that your money will grow, investing for the long-term should enable you to ride out any ups and downs in the market. Consider investing in sectors or companies that do well from a high inflationary environment. Diversifying across a range of countries, industries, companies and asset types is a good idea.
3. Fix your mortgage. If the Bank of England’s rate rises have been good for savers, they have been terrible for those with mortgages. With more rises expected, if you are on a tracker or variable-rate mortgage, or your fixed-rate deal is coming to an end soon, now may be the time to consider switching to a new fixed-rate mortgage.
4. Be mindful about your money. When the cost of living is high, it’s even more important to be mindful about where and on what you are spending your money. Look to replace expensive brands with cheaper supermarket own-brand versions, make sure you are on the cheapest deals and do you need two streaming subscriptions? Check out cashback when shopping online and take advantage of deals and loyalty cards.

How can investing help with inflation?

If you have the money, time and risk appetite, then investing in assets such as funds, shares, and bonds could help shelter your cash from rising prices. History shows that over the long-term, investing in the stock market typically beats inflation, giving your money greater potential to increase in value over time.

Remember that investments can fall in value, as well as rise, and you may get back less than you invest. Be prepared to see your investments rise and fall but the longer you stay invested the more potential your money has to recover from any downturns and to grow.

Bottom line

There are a number of ways to measure the change in prices in an economy but the ONS has deemed RPI to be one of the most unreliable. RPI has been dropped as an official inflation measure in the UK and kept as a legacy measure because so many things are linked to it throughout the economy. It should disappear within the next decade.

CPI was introduced as a standard European measure, and CPIH is a variation that factors in the cost of housing and has since become the government’s measure of choice. CPIH calculates its averages differently to RPI, so tends to be consistently lower.

There’s a plan to align the two, so RPI more closely matches the methodology of CPIH. This is likely to be done gradually over time to avoid sudden changes.

Frequently asked questions

• Is CPI or RPI a better measure of inflation?

  RPI is not considered to be a reliable measure of inflation due to the way it is constructed and calculated. The Bank of England instead uses the CPI measure to set its inflation target.

• Is RPI the same as inflation?

  RPI is a measure of inflation that includes housing costs in its calculations. RPI was replaced by CPI as the official measure of inflation in 2013 although it is still used in the UK economy.

  From 2030, the government will stop using the retail price index (RPI) measure of inflation, instead, it will use the consumer prices index (CPI) measure.

• Is CPI and retail inflation the same?

  Retail inflation is measured by the CPI, which tracks the change in retail prices of daily goods and services which households buy.

• Why is CPI not a good measure of inflation?

  While CPI is the preferred measure of inflation, it is inherently flawed because it can never calculate all of the activity in an economy. The figure will always be an average of all the items that the ONS tracks, which may be very different to your own personal inflation rate. CPI also excludes owner-occupiers’ housing costs (OOH), which are a big part of consumer spending.

• How much higher is RPI than CPI?

  In the latest inflation figures from the ONS for May 2023, RPI measured 11.3% while CPI was 8.7%.

• Why did CPI replace RPI?

  CPI replaces RPI as the main measure of inflation because it is deemed to be more accurate and more consistent with the measure of inflation used by the Bank of England. It also became the accepted measure across the EU.