RPI vs CPI: meaning, difference between ONS UK inflation rate measures - what do they mean for cost of living?

The UK inflation rate provided some cheer on Wednesday (16 August), as Office for National Statistics (ONS) data showed it fell again in July.

A big drop in energy bills as a result of the Ofgem energy price cap helped the headline rate of the Consumer Prices Index (CPI) fall from 7.9% to 6.8%. The rate of price rises is now at its lowest level for 17 months.

While it means prices are still rising and that the cost of living crisis is still very much with us, the fact that price hikes are slowing down could allow wages - and therefore purchasing power - to keep up with inflation, if not overtake it, in the near future. But it should be noted that real-terms spending power is considerably lower than it was two years ago when inflation began increasing, and that it may take a period of years to recover.

Some of the statistics within the headline inflation figure could also carry a sting in the tail for consumers. Core inflation remained stubbornly high, while services inflation increased. It could be a sign of so-called ‘sticky’ inflation in the UK economy - something the Bank of England is aiming to eradicate through interest rate hikes. Economists expect these points - as well as unexpectedly strong wage growth figures - will lead to an interest rates hike in September.

But how is inflation calculated - and what do the CPI and RPI mean? Here’s how to understand the ONS’s inflation measures.

How does the ONS measure inflation?

Inflation is an economic term used to describe price rises for goods and services - and therefore, the spending power of money - in a country over a particular period of time. The rate of these increases can vary based on a number of factors.

For example, if energy costs are high - as they currently are - the price of producing a particular item will go up. In turn, this production cost rise is then likely to increase the product’s shelf price, meaning it has undergone price inflation.

Every month, the ONS gauges whether prices are inflating or deflating by looking at roughly 180,000 prices for around 700 everyday items - it’s so-called ‘basket of goods’ in 140 locations across the UK. It then compares the current average price of these goods with the average it measured the previous year.

So, the 6.8% increase measured by the CPI in July 2023 means goods are priced 6.8% higher on average than they were 12 months previosuly. Translated into real terms, a product that cost £1 on average in July last year, cost just under £1.07 in July 2023. It’s also worth noting that last July’s inflation rate was sitting at 10.1%, so the latest rate is coming on top of what were already significant price hikes. Although the headline figure is lower month-on-month, it still means prices have been rising.

While these figures show the overall direction of travel for inflation, several categories are running higher and lower than the headline figure. For example, sugar has an inflation rate of 54.5% while diesel is deflating at a rate of 26.6%.

These statistics are not only used by the government to set the level of state benefits, among other things, but it also helps UK households to appraise how far their budgets will stretch and when they should make major purchases. However, the ONS takes two slightly different approaches in how it expresses price inflation.

What is the CPI index?

The CPI index is a measure of inflation measured solely using the ONS’s ‘basket of goods’ - a list of items deemed to be central to UK daily life, which is updated every year to reflect changing shopping habits.

For example, meat-free sausages, sports bras and antibacterial surface wipes were added in 2022, and E-bikes, home security cameras and frozen berries have just been added for this year. Casualties from the 2023 basket of goods include alcopops, digital compact cameras and CDs that are not in the UK Top 40.

This basket is weighted so that goods which are more important to households, such as milk, have a greater influence over the index overall than items that are less integral to daily life. These weightings also change over time as shopping habits change or new products move into the mainstream.

CPI is used by major economies across the globe and was formally adopted by the UK in 1996. As the official measure of inflation, it helps to determine the state pension, state benefits and statutory sick pay - rates that tend to be determined by the September CPI. However, it is not a perfect measure for the UK cost of living as it does not include several key household costs, like council tax or mortgage repayments.

What is the RPI index?

The RPI index essentially does the same job as the CPI but typically tracks slightly higher. In October 2022, it hit a record high of 14% but has since fallen to 9%.

Its main point of difference is it includes mortgage interest payments, so it is more influenced by house prices and interest rates than the CPI, which does not. It’s actually not used as an official measure of inflation by the Government because the method of calculating it is seen as inferior to CPI.

But it is still used to determine prices in some areas of public life, such as train tickets and phone contracts. The reason why it continues to be calculated is that it has been running in the UK throughout the 20th century and therefore provides a longer term yardstick for inflation.