What is the UK’s Retail Prices Index and how can it can help you understand inflation?

What is the UK’s Retail Prices Index and how can it can help you understand inflation?

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Inflation in the United Kingdom has been the highest in more than four decades, with the Consumer Prices Index peaking in October of last year when it reached a staggering height of 11.1%, the highest recorded level since 1981.

The recently published November inflation rates showed slight improvements, when the index only rose to 10.7%, but if official data are to be believed, this prevailing cost-of-living crisis will be here for a few months yet.

When you look at the annual inflation rates for the Retail Prices Index for November, however, the figure trumps both records. It was at an astonishing 14% in November 2022. What gives?

To explain, we would need to discuss the fundamentals of inflation and how it is calculated.

What is the Retail Prices Index
What is the UK Retail Prices Index? | Photo credit: Pexels

What is the UK’s Retail Prices Index? How is it different from the Consumer Prices Index?

The main point to remember is that the Retail Prices Index is a measure used by the UK Office for National Statistics for inflation. Essentially, it is a list of retail goods and services that the government deems to be representative of the general prices in the current economy. When the prices of the goods and services in the index go up or down, the changes are recorded and published by the government.

The origins of the Retail Prices Index could be traced to as far back as 1947, to replace the first official index of consumer prices introduced in 1914. The Retail Prices Index as it is known now was officially introduced in 1956.

However, times have changed significantly and the Retail Prices Index no longer meets the required standards for designation as a National Statistic. This is why the government instead emphasizes the use of the Consumer Prices Index (CPI), and a more comprehensive version of the measure that includes owner occupiers’ housing costs (CPIH).

Both indices implement the same basic approach to the measurement of inflation. Both measures monitor the continuous changing cost of a fixed basket of goods and services over time. They are both produced by calculating the individual prices of around 180,000 for over 650 representative

The key difference is in what those goods and services are. The Retail Prices Index covers different items compared to the Consumer Prices Index. They both have different population bases and thus have their own way in which individual price quotes are combined at the first stage of aggregation.

The biggest difference between the Retail Prices Index and the Consumer Prices Index is that the latter does not take into account costs like Council tax, mortgage interest payments, house depreciation, buildings insurance, other house purchase cost such as estate agents’ and conveyancing fees, TV license, road fund license, and trades union subscriptions.

This difference makes the Retail Prices Index hugely susceptible to influences like house prices and interest rates.

The Retail Prices Index also includes a price index for cars which is based entirely on used car prices.

Meanwhile, the Consumer Prices Index covers certain charges and fees that are not included in the older index. These are stockbroker fees, university accommodation fees, foreign student tuition fees, and unit trust fees. The index for the purchase of new cars in the CPI is also quality adjusted and based on actual published prices for new cars.

The Retail Prices Index is meant to be representative of the majority of private UK households, but leaves out the highest earners and pensioner households dependent mainly on state benefits. It also includes expenditure both within the UK and abroad by UK households.

The Consumer Prices Index, on the other hand, is meant to represent all private UK households and as such includes the expenditure of institutional households like nursing homes and foreign visitors to the UK. Only expenditure within the UK is covered.

The Retail Prices Index was largely influenced by UK history
The Retail Prices Index was largely influenced by UK history. | Photo credit: Pexels

Why does the UK continue to use both the Retail Prices Index and Consumer Prices Index to measure inflation?

The reason why the UK measures inflation both through the Retail Prices Index and the Consumer Prices Index owes itself to the history of how these measures were introduced. The historical contexts of the both indices are very different.

The history of the Retail Prices Index

According to the Office for National Statistics, the first iterations of the Retail Prices Index started out as a compensation index, developed as an aid to protect ordinary workers from price increases associated with the World Wars. It was only after a number of iterations and developments, alongside significant worldwide events, that it came to be used as the main domestic measure of inflation.

The UK Government first pursued a systematic, continuous check on the increase in the cost of
living as far back as 1914. At the time the published figures initially covered only food, as time passed the index was expanded to cover clothing, fuel and some other items.

Changes to the index continued throughout the 1920s and 1930s but was increasingly getting criticism particularly in relation to the weights used. The critics pointed out that these weights were based on data from an even older 1904 survey of urban working class households’ expenditure and were influenced by subjective judgements of what constituted legitimate expenditure for a working class
family at the time.

The Ministry of Labour called to update the weights using the results from a large-scale household expenditure survey carried out from 1937 to 1938. However, by the time the results became available, the second World War had broken out and disrupted all further action.

The Retail Prices Index came as a result of the establishment of the Cost of Living Advisory Committee in 1946. Now that the results of the previous survey was available, this Committee produced an interim report in 1947 which advised that the cost of living index should be updated. They also called for a new
inquiry to collect spending data should be introduced.

The Committee also made significant changes to the selection and number of representative items for which prices should be collected. The result is the Interim Index of Retail Prices, introduced in June 1947 and continued with some minor modifications to 1956. By 1955, sufficient information from the Household Budget Inquiry became available to underpin a new index and this became the first official Retail Prices Index beginning in January 1956.

The history of the Consumer Prices Index

In comparison, how the Consumer Prices Index came to be introduced is more straightforward in nature. It was launched far later in 1996, and is meant to serve an internationally comparable measure of inflation which employs methodologies and structures that follow international legislation and guidelines.

It was first introduced in 1996 as the Harmonised Index of Consumer Prices (HICP), and was developed across the European Union for the purpose of assessing whether prospective members of European Monetary Union would pass the inflation convergence criteria and of acting as a measure of inflation used by the European Central Bank to assess price stability in the Euro area.

Because of the intent of its creation, a major requirement for the index was consistency in how it measures inflation across Europe in order to make reliable comparisons between EU Member States. Because the Retail Prices Index used so much of the UK’s local history to influence its creation, it could not satisfy this need.

The name of the index was officially changed In December 2003, when the National Statistician decided that the UK version of the HICP be referred to as the Consumer Prices Index in all National Statistics publications. This change did not, however, make the index any different from the HICP.

Eventually, the existence of both the Retail Prices Index and the Consumer Prices Index created problems in measuring inflation in the country. In 2012, the National Statistician Jil Matheson recognized a gap between estimates produced by the Retail Prices Index and the Consumer Prices Index.

The need to address that gap led to a consultation for improving the Retail Prices Index. Taking into account more than 400 responses from a significant number of individuals and a wide range of organizations, the National Statistician concluded the following year that the formula used to produce the index does not meet international standards and recommended that a new index be published.

“In developing her recommendations the National Statistician also noted that there is significant value
to users in maintaining the continuity of the existing RPI’s long time series without major change,
so that it may continue to be used for long-term indexation and for index-linked gilts and bonds in
accordance with user expectations,” the ONS declared.

“Therefore, while the arithmetic formulation would not be chosen were ONS constructing a new price
index, the National Statistician recommended that the formulae used at the elementary aggregate
level in the RPI should remain unchanged.”

To this day, the ONS recognizes that the Retail Prices Index continues to be widely used in contracts across the country, and as such continues to publish its results monthly, alongside its subcomponents and RPI excluding mortgage interest payments (RPIX).

However, the UK Statistics Authority and HM Treasury launched a consultation in 2020 on the authority’s proposal to address the shortcomings of the RPI. From 2030 (at the earliest), as outlined in the UK Statistics Authority response to the consultation, the CPIH methods and data sources will be introduced into the RPI. Additionally, the supplementary and lower-level indices of the RPI will be discontinued.

Inflation is expected to continue to 2023. | Photo credit: Pexels

How are inflation rates UK looking for 2023?

The most recent data published by the ONS saw the Consumer Prices Index rising by 10.7% in the 12 months to November 2022, down from 11.1% in October. When you include owner occupiers’ housing costs as in the CPIH, this figure was at 9.3% in the 12 months to November 2022, down from 9.6% in October, despite a 0.4% rise in the month to November 2022.

Although the annual rate eased between October and November 2022, the rates in these months are the highest observed by the government for over 40 years. According to the office, the October figure was the highest annual CPI inflation rate in the National Statistic series, which began in January 1997.

The ONS noted that estimates of the indicative modelled consumer price inflation suggest that the CPI rate would have last been higher than the October 2022 figure in October 1981, where the estimate for the annual inflation rate was 11.2%. The CPI monthly rate was 0.4% in November 2022, compared with 0.7% in November 2021.

According to data, the main drivers of the annual inflation rate for CPIH and CPI are the same where they are common to both measures. The owner occupiers’ housing costs (OOH) component make a significant difference, however, as it accounts for around 17% of the CPIH, and is the main driver for disparity between the CPIH and CPI inflation rates. These came from housing and household services (principally from electricity, gas, and other fuels), and food and non-alcoholic beverages.

For the two months of October and November 2022, the largest factors pulling on the change in annual inflation rates came from transport, particularly motor fuels. Soaring prices in restaurants, cafes and pubs, meanwhile, contribute the largest to its rise, partially offsetting the trend.

The ONS maintains that the CPIH remains as its lead and most comprehensive measure of inflation as it extends the Consumer Prices Index to include a measure of the costs associated with owning, maintaining and living in one’s own home. These are known as owner occupiers’ housing costs (OOH) and are, along with Council Tax, significant expenses for many households not included in the CPI.

The Bank of England expects inflation to fall midway into the new year, owing to the government’s new six-month scheme to cap energy bills for households and businesses, as well as the easing of the production of imported goods. Demand for goods and services in the UK are also expected to go down, exerting downward pressure on prices.

Last month, the Bank of England also raised interest rates (its Bank Rate) by 0.5 percentage points to 3.5%, in a bid to return inflation to its 2% target.

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