What is the Consumer Price Index?

Discover how the Consumer Price Index measures inflation, and how this can affect your day-to-day life.

The Consumer Price Index (CPI) is one of the most common measures of inflation in the UK.

It is expressed as a percentage to detail the average annual rise or fall in the cost of goods and services.

How is CPI calculated?

The Office for National Statistics (ONS) calculates CPI every month by measuring the average cost of around 700 popular goods and services, and comparing this to the previous year. Some 180,000 price quotations are collected each month in order to generate the CPI figure.

The percentage is calculated by dividing the average cost of all items by the previous year’s average, then multiplying by 100.

The goods and services in the “shopping basket” used to calculate CPI are reviewed and altered each year to reflect changes in consumer spending habits. In 2019, smart speakers and electric toothbrushes were among the items added to the basket, while envelopes and three-piece suites were among those removed.

A detailed report, including the major changes discovered in individual items, is published on the ONS website each month.

Why does inflation matter?

Inflation is an important measure for the value of the pound.

If inflation is positive, that means you can buy less goods or services with your money.

Savers are encouraged to ensure that their money is earning more interest than the inflation figure. If it’s not, they’re becoming poorer in ‘real terms’.

Inflation is also commonly used to measure the performance of the economy. The Bank of England monitors CPI and sets itself a target of 2% to create a healthy economy. If CPI is too far off this, it will manipulate interest rates in order to bring it closer to their target.

CPI can also be a determining factor in a government’s decision to raise or cut taxes or benefits. For example, the annual rise in state pension payments is based on the highest of the CPI figure, average earnings growth, or 2.5%.

What are the other measures of inflation?

Here are the two other major measures of inflation used in the UK.

  • CPI + housing costs (CPIH). This is based on the CPI “basket”, plus costs associated with owning, maintaining and living in a house. Over 300,000 quotes are gathered to measure these extra costs, including the average price of energy bills and council tax.
  • Retail price index (RPI). The “basket” used to measure RPI differs to CPI. The main difference is that purchases typically made by high-earners, pensioners and tourists are excluded. It is used to justify rises in student loan interest and train fares among other things. Historically, the RPI figure is higher than CPI. It has been widely criticised for being an inaccurate measure of inflation. In 2018, Bank of England governor Mark Carney suggested it should be scrapped altogether.

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