Inflation has become headline news over the last two years. But why are there two measures - RPI and CPI inflation?
In very basic terms, inflation is the rate at which prices go up across the economy over time. So, it's essentially a measure of how hot - or cold - our economy is. It can also be seen as the speed at which the value of the pounds in our pockets are being eroded.
If it's too hot (as it has been since late-2021) or too cold, the amount we spend on goods and services is likely to fall and it becomes harder for the economy to grow. The UK's official statistics body the Office for National Statistics (ONS) calculates the inflation rate each month.
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The CPI - the headline rate of inflation - peaked at 11.1% back in October 2022 but has steadily dropped since then - albeit with some surprises that have kept interest rates higher for longer. A fall in the inflation rate means prices are still rising, just not as quickly.
As of March, the latest month for which we have data, inflation was 3.2% higher year-on-year. It means the price rises seen in March 2024 built on the huge 10.1% increase seen in the year to March 2023. While the figure is lower now than it was a year ago because record interest rates have cooled the economy down, this drop is also a reflection of how high the inflation figures were last year.
So, what exactly are the RPI and CPI - and what do they mean for your finances?
What is CPI inflation?
The Consumer Prices Index, or CPI, is the official measure for inflation. It also looks at the rate of change in prices for goods and services over a 12 month period. The current rate of the CPI stands at 3.2% for 12 months to March 2024.
The reason why the CPI is the headline statistic for the UK is that it is an internationally recognised measure of the rate of price rises. As well as being the world's foremost inflation statistic, it also means our figures are directly comparable with those of other nations, even though our economy works in a uniquely different way.
To measure the CPI each month, the ONS looks at around 180,000 prices of 730 typical goods and services to see how prices have changed. This 'shopping basket' of items is reviewed each year to ensure the statistic keeps up with people's ever-evolving spending habits.
For example, the 2024 review reflected the move out of the Covid 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, richer households have seen a lower inflation rate, generally, compared to poorer households given they are likely to spend a lower proportion of their monthly income on key goods and services, like food and energy. You can see what your personal inflation rate is using the ONS inflation calculator.
As well as showing you how much your bills and purchases have gone up or down in price over the past year, the CPI has a real-world impact on some costs. For example, it is used to set most broadband and mobile bills each spring, and September's CPI plays a key roll in setting the state pension and other benefits, like Universal Credit. Here are other things the CPI sets and influences:
- Public sector pensions
- Pensions lifetime allowance
- Statutory sick pay
What is RPI inflation?
The RPI, or Retail Prices Index, another index used to measure rises and falls in the cost of goods and services over time. As of March, its annual rate was 4.3%. It tends to track higher than the CPI because it includes costs associated with home ownership.
RPI was the original official consumer price inflation measure. It was first implemented in 1956 and was the only measure of its kind for the health of the UK economy.
But in 1996, it was replaced by the CPI as the UK's headline rate and is now an unofficial statistic due to the way it's calculated not being up to modern standards. Although it is is no longer relevant as a measure of recent price hikes, it does allow us to see how inflation has changed since the 1950s.
Where it does still have relevance is when it comes to setting cost increases for some bills and services. For example, it is used by some broadband firms to set April bill hikes, and it is also used by the government to set annual rail ticket price increases.
Here are some of the other things RPI sets or influences:
- Tobacco duty
- Air passenger duty
- Road tax
- Alcohol duty
- Final salary pension payments
- Interest in student loans
- income from index-linked annuities
What is CPIH inflation?
The CPIH is another related measure the ONS uses - it is the Consumer Price Index including owner occupiers’ housing (OOH) costs. It sat at 3.8% in March 2024.
It is similar to CPI, but includes the costs of owning, maintaining and living in a home. It means it also shares characteristics with the 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 a savings account or through wage increases) the value of your cash will erode over time.
So, if your savings are receiving interest of 5% and inflation is 6%, that pot of money will be losing spending power. Likewise, if your wages do not keep up with inflation, then you will effectively get poorer over time.
Most 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 being that if prices are going up in the near-future, you may as well complete a purchase today. It also means your wages are more likely to stay in touch with the rate at which spending power is being eroded.
At present, wages are outpacing inflation. There are also many savings accounts that are beating inflation, although you may need to act fast to get the best deal given the Bank of England is likely to cut interest rates later in 2024.
What impact does low inflation have?
Low inflation means prices are rising at a slow rate. Meanwhile, deflation means prices are falling.
Both scenarios may sound like good news after two-and-a-half years of large price hikes. But they 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 decrease. With wages likely to outpace the rate of price rises, consumers are more likely to be incentivised to hold onto their disposable incomes, which means less money will move around the economy and the government's tax revenues will fall.
In a deflation scenario, these effects are only likely to be turbo-charged. After all, why spend your money now if what you're buying could be cheaper next week?
It's expected that the UK could see some deflation over the next two to three years as the economy recovers from the inflation crisis seen between 2021 and 2023.
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