Time for the Retail Price Index to shine as a measure of domestic energy inflation

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by Shaun Richards

Today is one that I have in a sense been hoping for and but also fearing. The latter is because we see how people are being made worse off. But the former is the case I have been making over the past decade for the Retail Prices Index or RPI as a measure of inflation. We can look at it in the arena of what is the hot topic this month which is the rise in the price of domestic fuel due to the 54% rise in the Ofgem price cap. Below are the numbers that I presented at the Better Statistics conference at the Royal Statistical Society last Wednesday.

We can now move on to how this will be reflected in the consumer inflation numbers?

Retail Prices Index ( weight 4.5%) will see a 2.43% rise in inflation because of this  and 1.8% in October ceteris paribus.

The CPIH measure ( weight 2.7%) will see a 1.3% rise in inflation this month because of this 1.08% in October ceteris paribus.

I will just let those numbers settle in for a moment and simply remind you that the Bank of England inflation target is 2% per annum.

There are various points of note here but the main one is that it is the “not a national statistic” RPI which is representing the impact of the surge in energy prices more accurately due to the higher weight it has compared to the “lead” inflation indicator called CPIH. As you can see it makes quite a material difference. This will repeat in October when it will also represent the upward move then more realistically. We do bot yet know what the October change will be but due to some more recent lower gas prices ( the UK is benefiting from a combination of its LNG infrastructure and American gas) the most recent estimate I have seen is that the rise will be 32%.

One way of explaining part of this is a subject I have covered many times which is Imputed Rents or Rental Equivalence. Their use in the “lead” inflation measure covers 17.3% of the index. So they only have 82.7% of it for other things which reduces their weights or importance. This 17.3% is rising at an annual rate of 2.9% ( yes in one of the biggest surges in house prices we have experienced) so it acts as a brake on the numbers in two ways.

The IFS

Here are the views of the Institute for Fiscal Studies.

A key driver of inflation is the increased cost of energy; Ofgem’s updated energy tariff cap came into effect in April, raising the cap on average household bills on gas and electricity by 54% from the previous month, meaning a 70% year-on-year increase. In addition to the dramatic rise in the cost of gas and electricity, other factors such as the continuation of the war in Ukraine further increased prices of items such as petrol and food as well.

You will find that that they have been doing some maths.

However, as poorest households spend more of their total budget on gas and electricity, we now see inflation hitting the poorest households harder. In April, the bottom 10% of the population in terms of income faced a rate of inflation rate of 10.9%, which was 3 percentage points higher than the inflation rate of the richest 10%. Most of this difference comes from the fact that the poorest households spend 11% of their total household budget on gas and electricity, compared to 4% for the richest households.

As you can see they have almost managed to invent the already existing RPI inflation measure. Quite a lot of trouble to get a slightly lower answer. You might have thought that excluding the top 4% as it does would help in this regard. But you see they have a problem.

This will over time likely result in parallel collection for, and production of, the RPI and reduce its appropriateness as a measure of inflation even further. The cost of production will rise. The usefulness of the measure will diminish. The logical outcome must be the eventual discontinuation of the RPI.

That was from the 2015 Inflation Review from the Director of the IFS Paul Johnson.

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So the RPI was so bad he has needed to reinvent it 7 years later.

Energy Prices

We can take the impact further and argue it is under recorded. What do I mean? Inflation numbers are weighted on what we have spent ( there are surveys such as the UK living costs one for example). The problem is that when you have a very large change they get left behind because the new reality of domestic fuel prices being 50% higher is not in the weights and that will get worse in October.

Let me put that another way. If you look at the weight in CPIH and use that yo look at likely energy expenditure then if you do the maths average annual expenditure is £74,000 and may be £100,000 in October. This is a nonsense and shows the weights are too low but that the RPI is our best effort.

Rather different to all the official propaganda over the years!

Housing Costs

Let me give you our 3 main inflation measures and look at the influence of this area.

The all items RPI annual rate is 11.1%, up from 9.0% last month.

The Consumer Prices Index (CPI) rose by 9.0% in the 12 months to April 2022, up from 7.0% in March.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH) rose by 7.8% in the 12 months to April 2022, up from 6.2% in March.

The RPI is influenced in this area by a combination of house prices and mortgage costs ( which has an element of house prices and mortgage rates). Why are they doing?

UK average house prices increased by 9.8% over the year to March 2022, down from 11.3% in February 2022.

Mortgage payments have been kept down by the impact of the interest-rate cuts and QE bond buying but they are now in play as they rose by 1.7% month on month in April as they catch up with bond yields.

CPI simply ignores them as too difficult ( code for rises too fast)

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CPIH manages to take an area of high inflation and produces a low number. It does this by assuming that if you own your own home you pay rent to yourself. How much do you pay?

Private rental prices paid by tenants in the UK rose by 2.7% in the 12 months to April 2022, up from 2.4% in the 12 months to March 2022.

There you go job done! You take an area of high inflation and at a stroke it is solved! Or as the band America put it.

You can do magic
You can have anything that you desire
Magic, and you know
You’re the one who can put out the fire

Comment

When inflation rises like this we see which inflation measures have been swimming naked to misquote Warren Buffett. When the numbers are small I understand that it is easy to ignore but now they are large we are seeing the reality of the situation as a gap between 11.1% and 7.8% is material. It is not good enough to claim the RPI is wrong as our statistical authorities have done when they have come up with something worse. Also in twenty years they have failed to put full housing costs in the CPI measure which we have to regard as deliberate.

The much maligned RPI is performing better in its measurement of housing costs and now we find it is also doing so in the area of energy costs. I am not sure how much more our supposed authorities could have embarrassed themselves. It leads to rumours that staff at the ONS have asked for their pay rises to be based on the RPI but I cannot categorically confirm that.

No inflation measure is perfect and last month I took a look at an area of dispute about the RPI which is clothing costs. If you say that is correct then you can knock 0.3% off it but it does not materially change the argument.

Let me finish off by pointing out we have a new cost of living measure called the HCI. I have supported it but sadly the Office of National Statistics has proceeded at the pace of a snail which means after years it is not ready today. Oh and it does not have the house price ( capital component in its terms). Sound familiar?

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