Consumer Prices Index (CPI) inflation increased to 9.1% in the 12 months to May 2022, up from 9% in April. This means that the cost of living is rising at its highest level in 40 years.
Much of this latest increase was caused by rising prices of food and non-alcoholic drinks this year, compared to falls last year - things that we really can’t avoid purchasing. And of course the high price of gas and electricity which, although it is summer, we still need to use.
Unsurprisingly to those who drive, another major contributor was the price of fuel at the petrol pump. In May 2022 average petrol prices stood at 165.9 pence per litre (the highest price ever recorded), compared to 127.2 pence per litre a year earlier.
There are some items that have actually fallen in price. The largest, partially offsetting, downward contribution to the change in the 12-month inflation rate came from recreation and culture. The overall price of games, toys and hobbies fell by 2.4% this year, compared with a rise of 2.8% a year earlier. This largely reflects price changes for computer games, particularly computer game downloads – so anyone who doesn’t use computer games will not see the benefit of these price reductions.
What are the other measures of inflation?
Some of you may remember that before the Consumer Prices Index was used as a measure of the rising cost of living, it was the Retail Prices Index (RPI) that was widely referred to. And RPI in the 12 months to May 2022 was a whopping 11.7%.
There is yet another index known as the CPIH, which the Office for National Statistics (ONS) says is the most comprehensive measure and an index that is expected to replace CPI in 2030. It extends the CPI as it includes a measure of the costs associated with owning, maintaining and living in your home, as well as council tax. These things are arguably a major part of household budgets. CPIH rose by 7.9% over the last 12 months.
Although the ONS seems to prefer the CPIH as a better measure of inflation, CPI is still the index that the government target of 2% is linked to and is therefore widely referred to and used, and RPI is also still being used to calculate the price rise of many things.
What is the difference between CPI and RPI and which is likely to be most accurate?
The difference between CPI and RPI is down to a couple of things. RPI includes the costs of housing (mortgage interest costs, house prices and council tax, for example) and is therefore heavily influenced by these things, while CPI does not.
But that’s only part of it.
A key reason is the way the two indices are calculated. The RPI is an arithmetic mean; the prices of everything to be included in it are simply added up and divided by the number of items. The CPI on the other hand is a geometric mean; it is calculated by multiplying the prices of all the items together and then taking the nth root of them, where “n” is the number of items involved.
RPI was replaced by CPI in 2013 and mainly because of the way it is calculated, the ONS continues to see RPI as “a very poor measure of general inflation, at times greatly overestimating and at other times underestimating changes in prices and how these prices are experienced.” The ONS also states that RPI is more likely to overstate inflation than understate it.
As a result RPI is usually a higher figure than CPI.
In the past, RPI was used for the increase of many prices and benefits – so as well as increases to the train fares for example, it was also used for working out the interest earned on National Savings index linked certificates and the State Pension.
But once the CPI was introduced this changed in a number of cases. While train fare price rises are still pegged to RPI (although the latest increase was capped in the face of the rise in the cost of living crisis), Index Linked Certificates are now linked to the lower CPI. So too is the State Pension, as part of the triple lock guarantee; in the past it was RPI.
There are some things that will benefit some of us, that are still linked to RPI, such as some final salary pension payments (although many of these are now also using CPI) and income from index-linked annuities, but there are also many things that are detrimental to us that have continued to use RPI such as:
· Mobile phone tariffs
· Air passenger duty
· Car tax
· Tobacco duty
· Alcohol duty
· Interest on student loans
It’s interesting how the government still uses RPI as a measure to calculate an increase in these things, even though the ONS does not value it as a useful index any more.
Critics call this convenient “inflation shopping” where the government links expenses, such as the State Pension to lower CPI, and income-generators, like car tax, to higher RPI.
What does all this mean for me?
Regardless of all of this, the bottom line is that inflation is actually a very personal thing, as it depends on what you regularly purchase. For example if you don’t drive, you won’t feel the price hike of petrol in your pocket and if you are very careful with the amount of gas and electricity you use, you’ll be able to reduce your personal rate of inflation in that regard.
It can also come down to some of the smallest things – whether you drink skimmed or full fat milk? Whether you drink beer, wine or mineral water?
However, it’s hard to ignore that there is definitely a cost of living crisis and while savings rates are rising in the wake of Bank of England base rate rises, even the very best rates on the market fall well below the rise in the cost of living. That said, it still makes sense to find the best rates you can in accounts that suit your requirements, in order to mitigate inflation erosion.
And if you don’t need to keep as much as you do in cash, perhaps you’d like to see if there is anything else that you can consider.
If you’re worried about rising inflation and think you might be holding too much in cash, perhaps you'd like to explore other options, so why not get in touch. We’re offering all those with £100,000 or more in savings, investments or pensions a FREE financial planning review with one of our TPO colleagues, worth £500. You can find out more here.
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