The difference between CPI and RPI inflation - and why it matters
The consumer price index (CPI) and retail price index (RPI) are both important indicators of inflation. But what is the difference and why do they matter?
I keep being asked about the difference between the consumer price index (CPI) and the retail price index (RPI) measures of inflation. The immediate answer is that they include slightly different things: RPI includes the costs of housing (mortgage interest costs, house prices and council tax, for example) and is therefore heavily influenced by these things, while CPI does not.
However, it isn’t that simple. If it were, we might have seen RPI fall below CPI as mortgage rates collapsed from 2008, for example.
The complicated bit – and the more relevant difference between the two – comes in the calculations. The RPI is an arithmetic mean; the prices of everything to be included in it are simply added up and divided by the number of items. The CPI is a geometric mean; it is calculated by multiplying the prices of all the items together and then taking the nth root of them, where “n” is the number of items involved.
Look on the ONS site and you will see that it really isn’t mad for the RPI. It lost its status as a national statistic back in 2013 and the latest release on the matter is pretty clear that it is considered “a very poor measure of general inflation at times greatly over estimating and at other times underestimating changes in prices and how these prices are experienced.”
The ONS also reckons that it is more likely to overstate than understate inflation “although it is impossible to be precise about the extent of any upwards bias.”
It is also the case, says the ONS, that “an advantageous property of the geometric mean is that it can better reflect changes in consumer spending patterns relative to changes in the price of goods and services.” That may be so, but the real advantage to the government of using a geometric mean is that it is always below or equal to the arithmetic mean.
So much so that the so called “formula effect” tends to produce a significant difference in the different indices (see the ONS chart below) with the RPI usually ending up between 0.7 and one percentage point higher than other measures and sometimes rather more: in June 2022 CPI was 9.4% and RPI was 11.9%. That’s a meaningful difference and might go some way to explaining why the government still uses RPI to calculate all sorts of things – despite it being of no use to the ONS as a national statistic.
Look to the list of things CPI is considered useful for and you will mostly see that it involves calculating rises in payments from the government to the public (jobseekers allowance, the state pension, universal credit, housing benefit and personal independence payments for example).
Look to the list of things that use generally significantly higher RPI and you will see they mostly involve the calculation of rises in payments from the public to the government (interest on student loans, alcohol duty, tobacco duty, car tax and air passenger duty for example). Who could have guessed it would end up that way around?
According to the latest inflation data, published on 20 July, CPIH rose by 8.2% in the 12 months to June 2022, up from 7.9% in May. Meanwhile, the CPI index rose 9.4% over the same period, and the RPI rate hit 11.8%.
The largest contributor to the headline inflation reading this month was housing and household services, and transport. Surging oil and gas prices have pushed the cost of hydrocarbon fuels up across the board, with everything from petrol to heating oil and motor oil jumping in price.
Motor fuels inflation hit 42.3% in June and inflation in the transport bracket hit 15.2% overall. The biggest driver of this price inflation was petrol. Average petrol prices stood at 184p per litre in June 2022, compared with 129.7p per litre a year earlier.
Food and non-alcoholic beverage prices are also having a substantial impact on the headline inflation rate. Prices in this class rose 9.8% in the year to June, mainly driven by price movements in the price of milk, cheese and eggs. According to data from the Department for Environment, Food & Rural Affairs, farmgate milk prices jumped 5% in May to 40.4p a litre, up from around 30p last year, an increase of 35% reflecting higher costs for farmers.
While the prices of most goods and services are still rising, there are some bright spots in the data. The annual inflation rate for clothing and footwear was 6.1% in the year to June 2022, down from 6.9% in May. The price of second-hand cars has also started to rollover. Prices declined 2.5% in the month, the fifth consecutive decline.
Overall, just five of the 12 different categories monitored by the Office for National Statistics were responsible for the headline increase in the inflation figures