The UK has two well-known measures of inflation that often tell different stories: the Retail Prices Index, known as RPI, and the Consumer Prices Index, known as CPI. CPI is the official measure the Bank of England targets, while RPI is older, usually higher and still used in a surprising number of places, from index-linked gilts to some student loans and price rises. With September’s UK inflation figures due next week, it is worth knowing why the two numbers differ and why traders still care about both.
A quick history
RPI was first published in 1947 and for decades was the main measure of UK inflation. CPI was introduced in the 1990s as part of a European approach to measuring prices and became the Bank of England’s target in 2003, with the goal set at 2%. In 2013 the UK statistics authority stopped treating RPI as a designated National Statistic because of concerns about how it was calculated. It continues to be published because so many contracts and financial products depend on it.
Alongside CPI, the Office for National Statistics also publishes CPIH, which adds owner-occupiers’ housing costs. CPIH is the ONS’s preferred measure, but CPI remains the one the Bank of England targets.
Why RPI is usually higher
The biggest reason is a technical difference known as the formula effect. When statisticians combine the prices of individual items, CPI mostly uses a geometric average, while RPI uses arithmetic methods, including one known as the Carli formula. The arithmetic approach tends to produce a higher result, particularly for items with volatile prices such as clothing. That alone has often added close to a percentage point a year to RPI compared with CPI.
The second reason is coverage. RPI includes some housing costs that CPI leaves out, such as mortgage interest payments and council tax. When interest rates rise, mortgage costs climb and RPI can jump well above CPI. The two indices also cover slightly different groups of households.
Where RPI still matters
The most important use for traders is in the gilt market. Index-linked gilts pay interest and repay principal adjusted for RPI inflation, with a lag, so investors who hold them are effectively receiving RPI-linked returns. Our guide to gilts covers the basics, and our explainer on breakeven inflation shows how traders compare inflation-linked and conventional bonds to judge what the market expects.
RPI also feeds into some regulated prices, some pension arrangements, interest on some student loans and certain commercial contracts.
The 2030 change
In 2020 the government and the UK statistics authority confirmed that RPI will be brought into line with CPIH from 2030, effectively adopting CPIH’s methods and data while keeping the RPI name. Because CPIH has typically run lower than RPI, the change will reduce the value of future RPI-linked payments. That matters a great deal for holders of long-dated index-linked gilts and for pension funds, and it remains part of the background whenever traders discuss the linker market.
What this means for traders
For most trading decisions, CPI is the headline that moves markets, because it shapes expectations for Bank of England policy. Our guide to how UK CPI feeds into BoE policy explains that chain. Gilt yields and sterling tend to react to CPI surprises, as covered in how gilt yields react to UK inflation.
RPI matters more for specific corners of the market, especially index-linked gilts and anything with contracts tied to it. It also helps explain why everyday price rises in phone or broadband contracts, where RPI was once common, have sometimes run ahead of the official inflation rate.
Common mistakes
The first mistake is comparing an RPI figure from one source with a CPI figure from another and drawing conclusions about the trend. The second is assuming the Bank of England targets RPI. The third is ignoring the 2030 change when thinking about long-dated linkers. Always check which measure a headline refers to.
Bringing it together
CPI is the target, RPI is the legacy measure that still matters in key places, and the gap between them comes from formulas and housing costs. Knowing which one you are looking at makes inflation days much clearer.
If you would like an honest view of how prepared you are to trade UK data with a clear plan, our free trader assessment is a sensible starting point.
