UK retail price index reform


SUMMARY

The Retail Price Index (RPI) is often used in real estate documents, for example for indexed rents or adjustments to service limits. The Chancellor said the RPI will be abolished in 2030. This article examines what could replace it.

CONTEXT

RPI is a measure of inflation that measures the change in the cost of a representative sample of retail goods and services. In real estate transactions, the RPI is used to measure rent increases, load limits (these are often indexed by reference to the RPI) and other payments and contract values, such as ground rent. RPI is the oldest measure of consumer prices in the UK and is used throughout the economy and in other financial contracts. It is calculated and published by the Office of National Statistics (ONS).

There have been recognized long-term problems with the RPI in that it does not always accurately reflect the rate of inflation, sometimes underestimating inflation, but also significantly overestimating inflation. As early as 2015, a review of price indices by the Institute for Fiscal Studies recommended to the ONS that the RPI be maintained as a legacy measure only, and in 2017, the consumer price index (CPI) including Homeowner Housing Costs (CPIH) has become the lead inflation index in the ONS statistical publications.

The CPI is a measure that examines the weighted average of the prices of a basket of consumer goods and services such as transport, food and health care. It is calculated by taking the price changes for each item in the predetermined basket and averaging them.

A number of consultations were launched in 2018/19 on whether, for example, pension plans could move from RPI to CPI. Changes to the RPI may, in certain circumstances, require the approval of the Chancellor of the Exchequer before being implemented. The UK Statistics Authority (UKSA) has written to the Chancellor recommending that RPI cease, and given the time constraints associated with ceasing RPI (as legislation would be needed to change it), in parallel, RPI should be aligned with the CPIH.

The rationale for the date of 2030 is that the Chancellor had explained that making changes before that date would not be fair because holders of indexed government securities (which do not mature before that date) could be the losers. The proposed consultation on the RPI is continuing, but the methodology should be changed to bring the RPI into line with the CPIH, so that any increase is the same.

In November 2020, a response to the consultation was published.

WHAT SHOULD BE AN ALTERNATIVE TO RPI AND HOW WOULD IT BE MEASURED?

The Chancellor confirmed that the changes to the RPI will take place so that the values ​​of the RPI index are calculated using the same methods and data sources as those used for the CPIH. The change will integrate the methods and data sources of the CPI, including the CPIH, into the RPI.

In the previous decade, the CPIH gave a lower inflation measure than the RPI, about one percent lower per year on average. Starting in 2030, the RPI’s measure of inflation will likely be lower than it otherwise would have been by one percent on average per year, depending on the economic climate. RPI and CPIH will continue to be calculated and published as separate indices.

After 2030, the UKSA would no longer need the Chancellor’s agreement to implement the reforms proposed by the RPI.

HOW DO THE CHANGES IMPACT REAL ESTATE?

Since the CPIH gives a lower measure of inflation, rent increases are likely to be smaller and therefore returns will not be as large. Interestingly, what emerged from the response to the consultation was the emphasis on economic impacts and the value of these in developing a new measure.

Paragraph 44 of the response (see links below) states that arguing that consultation was too narrow or statistical rigor was irrelevant, many felt that economic impacts should be the primary consideration. These economic impacts are discussed in more detail in section 6 of the response. However, to minimize these impacts, some respondents focused on the idea of ​​setting the RPI equal to the CPIH plus an additional amount to reflect the difference in levels between the RPI and the CPIH. This idea was often summed up as “CPIH + X”. Respondents mainly suggested that “X” should be the average difference between CPIH and RPI, sometimes referred to as “wedge”, or directly using 100 basis points, 1 percent over CPIH. This theme was present in 23% of responses to question 1 and 10% of all responses. This has been postulated by individuals and organizations as well. Landlords may want to incorporate this into their lease negotiations.

The economic factors are likely even more important given the COVID-19 pandemic. It will be interesting to see if this has an impact on the copywriting in the months to come.


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