Retail Prices Index (RPI)

The Retail Prices Index (RPI) is a long-standing measure of inflation in the United Kingdom. Think of it as a traditional price tag on the country's cost of living. For decades, it was the headline measure, tracking the monthly change in the price of a representative 'basket of goods and services' consumed by the average household. The basket includes everything from a loaf of bread and a pint of milk to petrol prices and cinema tickets. While it has been largely superseded by the Consumer Prices Index (CPI) as the UK's official inflation statistic, the RPI is far from a historical relic. Its ghost lives on in the plumbing of the financial system, influencing everything from government bonds and pension payments to student loans and rail fares. Understanding the RPI is crucial, especially for UK investors, as its unique calculation method and inclusion of housing costs mean it often tells a different inflation story than its modern counterpart.

Imagine a giant, imaginary shopping basket filled with items that a typical family buys. Each month, the UK's Office for National Statistics (ONS) sends its price checkers out to record the cost of over 700 items in this basket from thousands of locations. This isn't just a static list; it's a living, breathing reflection of our habits.

• Out with the old, in with the new: The ONS updates the basket annually. For instance, as people started streaming more movies at home, the cost of a DVD player might have been replaced by the cost of a streaming subscription. This ensures the index reflects modern spending patterns.
• Weighting matters: Not all items are equal. The ONS 'weights' items based on their importance in the average household budget. Changes in petrol prices, for example, will have a much bigger impact on the final RPI figure than changes in the price of tea bags, simply because we spend more on fuel.

By tracking the total cost of this weighted basket over time, the RPI provides a figure for the rate of price increases—or inflation.

While both RPI and CPI aim to measure inflation, they are like two cousins who, despite their family resemblance, have some fundamental disagreements. This often leads to the RPI figure being higher than the CPI. The two main disputes are over housing and mathematics.

The single biggest practical difference is that RPI includes certain housing costs that CPI excludes. Most notably, RPI factors in mortgage interest payments and council tax. This makes RPI highly sensitive to changes in interest rates set by the Bank of England. When interest rates go up, mortgage payments rise, and RPI gets a direct upward push, regardless of what's happening to the price of groceries. Because of this, many economists argue that RPI is a less pure measure of consumer price inflation.

This is a statistical quirk, but with big consequences. The two indices use different mathematical formulas to average prices.

• RPI uses a formula called the Carli index, which is a type of arithmetic mean.
• CPI uses a formula called the Jevons index, which is a geometric mean.

Without diving into the complex math, the crucial takeaway is that the Carli formula used for RPI has a natural upward bias. This “formula effect” means that even if RPI and CPI measured the exact same items, RPI would almost always come out higher. The ONS itself has called this a flaw, and it's a key reason why RPI lost its status as a 'National Statistic'.

For a value investor, whose goal is to grow purchasing power over the long term, understanding inflation isn't just academic—it's essential. The return on your investment is only meaningful after you subtract the bite of inflation. This is your real return. While CPI is the official benchmark, RPI's legacy connections make it impossible to ignore.

1. It's Written into Contracts: Many long-term financial agreements are still linked to RPI.
   • Index-Linked Gilts: A significant portion of UK government bonds, known as index-linked gilts, have their interest payments and final principal value increased in line with the RPI. If you hold these bonds, RPI is your inflation measure.
   • Pensions: Many defined benefit pension schemes, particularly older ones, have their annual payment increases tied to the RPI.
   • Other Costs: Regulated prices for things like rail fares and student loan interest rates are often still calculated using RPI.
2. The Phasing Out Plan: The UK government and ONS plan to reform the RPI starting in 2030, effectively aligning its methodology with a version of the CPI that includes owner-occupier housing costs (known as CPIH). However, until then, and for the life of any RPI-linked contract you hold, this “legacy” index remains critically important. For investors, knowing which inflation measure affects your assets (like gilts) and your future liabilities (like living costs) is fundamental to protecting and growing your real wealth.