The government and the UK Statistics Authority (UKSA) have published their reply to the consultation launched earlier this year on the reform of the Retail Price Index (RPI) methodology, following the 2020 expenditure review.
The consultation proposed retaining the RPI, but suggested adopting a modified methodology to more closely align the RPI with the CPIH (the consumer price index including owner-occupied housing costs) so that the increases are the same.
However, the proposal requires the Chancellor’s consent, as the RPI is used in two specific government indexed gilts. The Chancellor announced that although he sees the “The statistical arguments of the reform approach envisaged by the UKSA”, in order to minimize the impact on the holders of these gilts, it is not in a position to consent to the implementation of methodological changes before 2030 (which is the final maturity date of the indexed gilts concerned). This means that the earliest the proposed changes can be made legally and practically by the UKSA will therefore be February 2030. The change, when it does occur, will bring the methods and data sources of the Consumer Price Index ( including owner-occupant housing costs (CPIH)) in the RPI. The CPIH gives a lower measure of inflation than the RPI, with the CPIH having been about 1% lower per year on average over the past decade. This means that RPI inflation can be expected to be lower from 2030 than it would have been otherwise.
PERCEIVED DEFAULT IN RPI
It has long been recognized that there were gaps in the composition of the RPI, meaning that it did not accurately reflect the rate of inflation.
“We have made it clear that the RPI is not a good measure, sometimes dramatically overestimating inflation and sometimes underestimating inflation, and we have consistently urged all members of government and the private sector to stop using it.“Sir David Norgrove, UKSA President
SUMMARY OF ALTERNATIVE INDICES
RETAIL PRICE INDEX
It is calculated and published by the Office of National Statistics (ONS), but it is an older measure of inflation. It is not considered the official UK inflation rate for statistical purposes. It is still published because it is used to calculate cost of living and salary increases and there are indexed securities and state gilts.
CONSUMER PRICE INDEX
It is one of the most frequently used statistics to identify periods of inflation or deflation. Changes in the CPI are used to assess price changes associated with the cost of living: it measures the average change in the costs of purchasing a typical “basket” of goods and services over a period of time in a given country. typical household.
The Institute for Fiscal Studies released a report on April 14, 2020 detailing how COVID-19 could change the way countries measure the CPI. The report details how consumer behavior has changed in the wake of the coronavirus pandemic and some items normally included in the ‘basket’, such as package holidays and meals out, were not available.
Consumer price index including owner-occupant housing costs.
PRACTICAL IMPACT ON REAL ESTATE
In real estate transactions, RPI can be used to measure increases in rent, payments and the value of contracts. Service charge ceilings can be indexed by reference to the RPI.
When the formulas used to calculate the RPI are changed to bring the index closer to the CPI, the likely practical effect of such a change will be to reduce rent increases when linked to increases in RPI. The CPIH gives a lower measure of inflation than the RPI, with the CPIH having been about 1% lower per year on average over the past decade. This means that RPI inflation can be expected to be lower from 2030 than it would have been otherwise. Parties who have negotiated clauses with the expectation of a better return from the RPI will not accept this change. Landlords may wish to address the issue in lease negotiations now by referring to CPIH plus 1.
Existing contracts and leases may contain wording that seeks to preserve the original calculation method even after a material change in RPI methodology or will contain a substitution provision if RPI is replaced or modified. It will be interesting to see how such clauses work in practice and whether the continued use of RPI is challenged or accepted.
In the meantime, when considering entering into new index trades, take the time to consider the appropriate index to refer to if the term of the contract extends beyond February 2030 (when it seems likely that the change be implemented). Existing leases should contain a substitution provision if RPI is replaced or changed, but parties should recognize in longer leases that cues are as much political as mathematical and may not do the work originally intended by the parties.