UK chancellor to consult on future of RPI inflation

Out-Law News | 04 Sep 2019 | 3:55 pm | 3 min. read

The UK will consult on whether to reform the way in which the retail prices index (RPI) measure of inflation is calculated, the chancellor of the exchequer has said.

The consultation will consider whether to address the perceived flaws with the measure by aligning it with the Consumer Prices Index including owner occupiers' housing costs (CPIH). However, the changes would not be made before 2025, as "some or all users of RPI will need substantial time to prepare".

UK Statistics Authority (UKSA) chair Sir David Norgrove wrote to the previous chancellor in March recommending that changes be made to the way in which RPI is calculated as a short-term measure, before publication of the rate was ultimately abolished. His intervention followed a report by the House of Lords Economic Affairs Committee, which called for immediate action to fix a known error in the RPI calculation method.

The UKSA cannot act unilaterally to address the error before 2030, as any correction would have a "material and detrimental" impact on index-linked bondholders.

The government legislated in 2010 to replace RPI with CPI as the measure of inflation for uprating benefits, tax thresholds and public sector and state pensions, as it deemed the rate "more appropriate". It continues to use RPI to uprate student loans and rail fares.

Meanwhile, many workplace pension schemes continue to uprate benefits based on RPI, as the rate is 'hard wired' into the scheme rules. The courts have heard a string of cases brought by employers seeking to switch to using CPI as a measure of inflation, which have been decided on a piecemeal basis after taking the particular wording of the different sets of scheme rules into account.

Pensions expert Alastair Meeks of Pinsent Masons, the law firm behind Out-Law, said: "There is general agreement that RPI is a poor measure of inflation. There is no agreement at all about what, if anything, should be done with it."

"The courts have heard a string of cases from aggrieved employers who discovered 20 years after the fact that they had been playing roulette depending on which firm of pension lawyers' boilerplate wording had crept into their trust deed and rules. Many have been stuck with RPI as a measure of inflation that no one regards as satisfactory and that has been downgraded from its former status as a national statistic but which is still produced, and which their rules require them to use," he said.

"Today's announcement is basically very good news indeed for those pension schemes. However, the government is hardly rushing: 2025-30 for implementation of the change is not breakneck speed. It will be even later before pension schemes will be able to reflect this in their valuations and funding plans. The difference in cost between the two measures is substantial, but until any change is made employers will need to be paying - and perhaps overpaying - contributions into their pension schemes on the existing basis," he said.

"The flipside is that investments that give returns by reference to RPI are going to be less valuable as they give correspondingly lower returns. Pension schemes may well find that they have lost on the swings what they had gained on the roundabouts", he said.

In a letter to Sir David Norgrove, chancellor Sajid Javed agreed that there are "flaws" in RPI as a measure of inflation. However, ceasing publication would "potentially be highly disruptive for the wide range of users of RPI ... could be damaging to the economy and the public finances".

The letter confirms that the government will consult on the date of the change in January 2020, and that UKSA will consult on the precise methodology. Javed has also confirmed that the government will not introduce further uses of RPI, as indicated in the October 2018 budget.

In response, Sir David Norgrove said: "We have been clear that the RPI is not a good measure, at times significantly overestimating inflation and at other times underestimating it, and have consistently urged all – in government and the private sector – to stop using it".

"We continue to urge the government and others to cease to use the RPI. It would be wrong for the government to continue to use a measure of inflation, which it itself accepts is flawed, where it has the opportunity to change," he said.