The Consumer Prices Index (CPI) has been hovering around the Bank of England’s 2% target for the past seven months, suggesting the worst of inflation is now in the rear-view mirror.
Although higher energy costs drove inflation up to 2.3% in October, prices are rising at a far slower rate than in recent history. At the peak of the cost-of-living crisis, inflation hit 11.1%.
If you hadn’t heard of CPI before then, you will almost certainly be familiar with the term now thanks to its prominence in the news in recent years. But how does it differ from other measures calculated by the Office for National Statistics (ONS)?
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We take a closer look at two key indices – the Consumer Prices Index and the Retail Prices Index (RPI). How do they differ and which matters most for your finances? Plus, what is the Consumer Prices Index including owner occupiers’ housing costs (CPIH)?
What is CPI inflation?
CPI is the official measure of inflation. It tells you how much the cost of goods and services has increased over the past year based on a representative basket of household items. A new report is published each month. MoneyWeek’s calendar of CPI release dates tells you when you can expect the next figures.
CPI is recognised internationally as a statistic. This means the UK’s figures are closely comparable with those of other nations, even though its economy works in a different way.
To measure CPI each month, the ONS looks at around 180,000 prices across almost 750 typical goods and services to see how prices have changed. This shopping basket is reviewed each year to ensure the statistic keeps up with people's evolving spending habits.
The 2024 review reflected the move away from the Covid-19 pandemic as hand sanitiser was dropped from the basket. Air fryers and rice cakes were two new products that were included.
While this basket gives us an inflation figure, it is worth noting that inflation varies from household to household. For example, pensioners are likely to spend more on energy than young working professionals. This means the recent increase in energy prices (10% at the start of October) is likely to hit their budgets harder.
You can see what your personal inflation rate is using the ONS inflation calculator.
From state pension to benefits, how is CPI used?
As well as showing you how much your bills and purchases have gone up or down in price over the past year, CPI has a real-world impact on some day-to-day costs. For example, September's CPI can play a key role in setting the state pension and other benefits like Universal Credit, public sector pensions and statutory sick pay.
Another thing to note with CPI is that the headline figure does not give you the full picture. Instead, it should be viewed as more of a broad sweep. Data within the data is more insightful if you're keen to understand how inflation is changing; for example, the Bank of England also looks at core inflation and services inflation when it decides how it will set interest rates. These are running at rates of 3.3% and 5% respectively.
Core inflation strips out categories that tend to see short, sharp fluctuations in prices, like food and energy. Services inflation covers things like hotel stays, airfares, educational costs and more. Services make up around 80% of the UK economy, so this is an important measure of how embedded inflation is in the domestic economy.
What is RPI inflation?
RPI is another index used to measure changing prices. It came in at 3.4% in October 2024. RPI tends to track higher than CPI because it includes costs associated with home ownership.
Originally, RPI was the UK’s official inflation statistic. It was first implemented in 1956. “Until the introduction of the UK CPI […] in 1996, the RPI and its derivatives were the only measures of UK consumer price inflation available to users,” the ONS says.
Given its age, RPI can give us a sense of how prices have changed since the 1950s, but CPI replaced RPI as the UK’s official measure in 2003. The Bank of England’s 2% target is based on CPI.
Where RPI does still have relevance is when it comes to setting cost increases for some bills and services. For example, it is used by the government to set annual rail ticket price increases. It is also used to set levies like road tax. Here are some of the other things RPI sets or influences:
- Tobacco duty
- Air passenger duty
- Alcohol duty
- Final salary pension payments
- Interest in student loans
- Income from index-linked annuities
What is CPIH inflation?
CPIH is another related measure calculated by the ONS. It stands for the Consumer Prices Index including owner occupiers’ housing costs. It came in at 3.2% in October.
CPIH is similar to CPI, but includes the costs of owning, maintaining and living in a home. This means it also shares characteristics with RPI.
CPIH is the ONS's best measure of UK inflation given it captures more of the economy than the other two measures. However, given the UK housing system is different to that of any other nation, it is not internationally comparable.
What does high inflation mean?
High inflation means costs are rising at a rapid rate. Unless your money is keeping up (e.g. in an inflation-busting savings account or through wage increases), the value of your cash will erode over time.
If your savings are earning interest of 4% and inflation is around 2%, remember that your real return is only 2%. Similarly, if you get a 6% pay rise and inflation is around 2%, your real wage increase is more like 4%.
When investing, there are some strategies you can follow to hedge against inflation, but investors have still identified rising prices as a major risk to portfolios.
Most western economists agree that having a manageable rate of inflation is not a bad thing. The Bank of England has a remit to keep inflation at 2% – a level it believes allows for a good level of spending that will boost economic growth. The reason is that, if prices are going up in the near future, you might as well complete a purchase today.
What is the impact of low inflation?
Low inflation means prices are rising at a slow rate. Meanwhile, deflation means prices are falling. If sustained for a long period, low inflation and deflation can indicate a weaker economy, with deflation likely to be particularly bad for GDP growth.
If inflation comes in below 2%, most economists believe that spending will generally decrease. With wages likely to outpace the rate of price rises, consumers are more likely to be incentivised to hold onto their disposable income, which means less money will move around the economy and the government's tax revenues will fall.
In a deflation scenario, these effects are likely to be turbo-charged. After all, why spend your money now if what you are buying could be cheaper next week?
At the moment, we are a long way away from this kind of scenario. Although inflation has slowed significantly from its peak, it could rise to around 2.75% by the end of the year, based on Bank of England forecasts. Core and services inflation remain particularly sticky. We share further details in our inflation outlook.
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