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News - 20 January 2007

So is inflation 3% or 4.4%?

It all depends on which index you use to measure it – the Consumer Prices Index (CPI) or the Retail Prices Index (RPI). So why do we have two indexes anyway?

According to the RPI inflation jumped from 3.9% in November to 4.4% in December 2006, the highest rate for 15 years and double the rate in December 2005.

According to the CPI inflation increased from 2.7% in November to 3% in December 2006, the highest rate for 10 years.

The Bank of England uses the CPI to measure inflation and it is this figure that triggers the need for an open letter from the Governor to the Chancellor if it goes above 3%. The target for the Bank is to keep inflation, at or as close to, 2%.

The RPI has a history going back to 1906 and it includes changes in the cost of a basket of common items but also mortgage interest payments and council tax and, possibly because it is used to negotiate pay settlements, it is the measure more familiar to the general public.

In the 1950s inflation according to the RPI measure averaged 4.3% and it declined to an average 3.5% in the 1960s before zooming up to 12.6% in the 1970s and dropping to an average 5.1% in the 1990s most of which was caused by high rates of inflation between 1990 and 1993.

Since 1993 inflation according to RPI has been an average of 2.6%

The CPI is an index that was devised to be compatible across Europe and excludes owner occupied housing costs. It should, in theory, include housing expenses but EU statisticians are still trying to work out how to do this. Average CPI across the EU is currently 1.9%.

Roughly speaking in the UK the Bank of England’s CPI target of 2% translates to an RPI target of 2.75%. In an added twist the Office for National Statistics has introduced a novel personal inflation calculator which allows individuals to assess their own rate of inflation which is directly reflected in their lifestyles and circumstances.

Read related items on:
Bank of England
Office of National Statisitics

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