What are the three main measures of inflation?

Inflation refers to the average or mean increase in the prices of everyday goods and services over a period of time. The Office for National Statistics (ONS) uses three measures to measure inflation: the Consumer Prices Index (CPI), the Consumer Prices Index including owner occupiers' housing costs (CPIH), and the Retail Prices Index. The ONS releases the respective figures every month. They usually indicate the rate of increase in prices for the year to the previous month of publication.

Inflation is important in relation to pay and reward as it is widely used to inform decisions over pay increases. This is because employees generally want to see their pay reflect changes in the cost of living. While employers support this aspiration and are generally happy to compensate staff for increases in the costs of living, they do not always do so at the same rate as the average increase in prices. This is why pay increases are often lower, on average, than inflation. A future article in our series will look at the current relationship between the two. 

CPI

The Consumer Prices Index (CPI), introduced in 1996, measures the average change over time in the prices of a selected basket of commonly purchased goods and services. This measure helps form the Government-set target for the Bank of England’s macroeconomic management of inflation, which is the main reason it gets such prominence in the media, even though it is NOT the ONS’s leading measure (see below). CPI uses a geometric mean, reached by calculating the total product of the given data set and then calculating the square root. This method almost always produces a lower mean than the traditional arithmetic mean used in the RPI (see below) though the geometric mean is considered to be more statistically accurate. The CPI measure excludes housing costs such as rents or associated charges such as council tax, making it a less comprehensive guide to ‘average inflation’. This is why the ONS created the CPIH measure, to assess the impact of these costs on inflation.

CPIH

The CPIH measure is the ONS’s leading measure of inflation. The CPIH combines the same elements as the CPI measure with the cost of owning/living in a home in the UK, taking into account the effect of council tax, and private sector rent payments. It does so according to an element termed ‘owner-occupiers’ housing costs’ or OOH, which is based on an estimate of private sector rents. This makes it a more comprehensive figure than the CPI as it reflects a more realistic picture of the true cost of living for households in the UK. Both the CPIH and the CPI estimates are typically lower than the remaining estimate, the RPI. This is mainly due to the differences in the way the three measures are calculated.

RPI

The Retail Prices Index (RPI) was established in 1947 and uses a traditional arithmetic mean. Unlike the CPI and the CPIH, the RPI directly includes housing costs such as mortgage payments, house price depreciation and rents, as well as council tax. However it excludes those in the top 4% of household earnings and pensioners. Together, these factors explain the variations in reported inflation rates when compared to the CPI and CPIH, as the RPI is often higher. The RPI is commonly used for wage negotiations, and official purposes such as tax allowance changes and social housing rent adjustments, despite being replaced as the official measure of inflation by CPI in 2003. It is also used to uprate Government bonds, and for increases in the prices of regulated services such as rail fares. Though it continues to publish it, the Office for National Statistics (ONS) has reclassified RPI as ‘not a national statistic’, and plans on phasing this measure out by 2030.