CPI, RPI and the true cost of clothing

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Have UK clothes prices gone up or down over the last 10 years? Most people would assume that the answer to this would be simple, just look at inflation. But not all inflation calculations are the same, they can use different formulas to calculate price changes and, as a result come to different conclusions.

Most people know that the UK’s Retail Price Index (RPI) differs from the Consumer Price Index (CPI), as RPI includes housing costs in the form of council tax and mortgage interest payments, but the differences between the two indices are deeper than this. For example when you compare clothing and footwear prices over the last twenty years, both CPI and RPI show prices declining during the first ten years, but for the second ten years a clear divergence appears.

The reason for this disparity comes down to calculation method. RPI uses the ‘Carli’ formula for around 30% of the prices it measures (including clothing and footwear), a measure that has previously been criticised for introducing an upward bias to inflation data. But even the initial decline is questionable! The Bank of England (BoE) have stated that annual CPI inflation may have been underestimated by up to 0.3% a year between 1997 and 2009 as a result of seasonal sales for clothing and footwear which saw discounts being captured by the data, but not the recovery back to normal prices as the sales ended. This led to a change in methodology being introduced at the start of 2010.

With inflation at the top of the BoE’s tolerance threshold, the Monetary Policy Committee will need to make a judgement on how quickly they need to raise interest rates. Understanding these intricacies of inflation measurement is a critical part of their role.

David Hooker – portfolio manager. Insight Investment, a BNY Mellon company

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