Consumer Price Index (CPI)

Inflation, the tendency of prices to rise and keep on rising is measured in the U.K. by the Consumer Prices Index (CPI). This official measure is calculated each month by taking a sample of goods and services that a typical household might buy, including food, heating, household goods, travel costs.

The figures show a trend for prices over the previous month but the number that attracts attention is the annual rate. This annual figure is the one used by the media, wage negotiators and policy makers.

In his Pre-Budget Report statement on 10th December 2003, Gordon Brown, the Chancellor of the Exchequer, changed the Government's inflation target to a new base: the Harmonised Index of Consumer Prices (HICP), which has been renamed the CPI. The level of the new CPI inflation target for the Bank of England's Monetary Policy Committee (MPC) was set at a symmetrical 2% with immediate effect.

HICPs were originally developed in the EU to assess whether prospective members of European Monetary Union would pass the required inflation convergence criterion and then of acting as the measure of inflation used by the European Central Bank to assess price stability in the euro area.

Pensions, benefits and index-linked gilts continue to be calculated on exactly the same basis as in the past, with reference to the all-items Retail Prices Index (RPI) or its derivatives.

However, there are significant differences between the CPI and the RPI. The CPI excludes a number of items that are included in RPI-X (the previous target inflation measure), mainly related to housing. These include council tax and a range of owner-occupier housing costs such as mortgage interest payments, house depreciation, buildings insurance, estate agents' and conveyancing fees.

The two indices are also calculated differently. The different techniques used to combine individual prices in the two indices also reduces CPI inflation relative to RPIX. This is called the formula effect. When Gordon Brown announced the changeover in target measure the annual rate of RPI-X exceeded the CPI by more than 1%.

The main measures of inflation published in the UK are:

• The Consumer Prices Index - based on an EU-wide formula allowing direct comparison of the inflation rate in the UK against that in the rest of Europe.
• The Retail Price Index (RPI) is an average measure of change in the prices of goods and services. Once published, it is never revised.
• RPI-X - this is RPI excluding mortgage costs. It was previously the target measure for the MPC with a symmetrical target of 2.5%
• RPI-Y - this is RPI with both mortgage costs and the impact of changes in taxation removed.

See also: UK Inflation history

Last Updated: May 2007 © Moneyextra.com

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