CPIH: The UK headline inflation measure

On the Tuesday 21st March 2017, the UK switched its headline inflation measure from CPI to CPIH.  This article examines what CPIH is, how it differs from CPI, why we are changing, why there is controversy around the measure and what the implications might be.

CPIH is similar to the Consumer Prices Index (CPI) but attempts to add a measure of owner occupiers’ housing costs. The “H” effectively stands for “Housing”.

You might have expected that all our inflation indices include housing costs, as they are a significant part of most people’s lives. Indeed, they are included in the UK’s other inflation index RPI, but not in CPI. Their exclusion from CPI goes back to when it was invented by the EU in the early 1990s. Statisticians could not agree on how best to measure housing costs, so they compromised and left them out.

Nearly a decade after the introduction of CPI as the UK’s main measure in 2003, and there was a general agreement that something needed to be done about the missing housing elements. Both ONS in the UK and Eurostat started to examine the options.

ONS’s controversial housing measure

ONS has created a version of what are called “Owner Occupiers’ Housing” costs, or OOH, and then added this to CPI (along with Council Tax prices) to create the new index called CPIH – see here. ONS are calculating OOH using something called “Rental Equivalence”. They argued that changes in the prices of rents are a good proxy for housing costs and there is no need to measure things such as house prices, house insurance, water rates etc.

The problem is though that evidence suggests that rents are not that good an estimate of all housing costs. A comparison of the housing costs monitored in RPI and OOH shows that the two seem fairly unrelated – see graph.

OOH

What determines rent prices is not so much the costs such as repairs and maintenance, but supply and demand. Whilst many housing costs such as maintenance continue to rise, rents can rise and fall for other reasons. For example, the Countrywide Letting Index highlighted in March 2017 that rents have fallen by 5% in London over the previous year as a result of 18% more properties being available and the number of renters rising just 3%.

Another problem with using rents is that should there be a change in government housing benefit policy, the data which ONS is using from the Valuation Office Agency may no longer be collected. Furthermore, should Jeremy Corbyn be elected, he has promised to bring in rent controls. At that point, the variation in the data will merely reflect government policy and it will become irrelevant for measuring housing inflation.

Finally, ONS freely admit that OOH is slow to react to housing price changes – typically a year late – a lag that results from rents being set only periodically.

The UK Statistics Authority (UKSA) are also concerned about the introduction of CPIH and removed its designation as a national statistic back in 2014. On 10th March 2017, UKSA re-affirmed that they are still unhappy with the approach ONS has taken on a number of grounds.

Other ways to measure housing inflation

There are other ways to measure housing inflation. The EU is now asking all member states to calculate housing costs a different way. They thought it important that real house prices were included in some way and that all costs related to buying and maintaining a home should be counted in their housing index. They have therefore adopted a method called “Net Acquisitions”.

Also if you’d have asked any person in the street, how to calculate housing inflation their answer would probably have been fairly simple.  List out all the many aspects you pay money for in relation to your house and then monitor their prices. Statisticians call this the “Payments” approach. ONS already collect this data, as it is largely how the RPI housing measure is calculated.

Effects of CPIH on the inflation rate

But as CPIH is already launched, what effect is it going to have on the headline rate we see every month? The answer is not a simple one and it depends in part on overall level of inflation.  When CPI inflation is above 2%, it is likely that CPIH will lower the headline inflation rate.  For example, should CPI inflation rates go up to around 3%, as the Bank of England predict they may soon, the reduction might be around 0.3%.

OOH scatterplot

This could start to have a significant impact on standards of living in the UK.  Benefits, tax allowances and many pensions are all generally linked to the headline inflation rate, as are many wage rises. Should inflation be consistently lowered by adopting CPIH, this will erode the standards of living of many people over time – particularly of the poor and elderly.

Concluding thoughts about CPIH

Back in 2003 when RPI was dropped in favour of CPI, the impact of changing housing costs was lost from the UK’s main inflation measure. There is thankfully now a consensus that housing needs to be included again and on one level CPIH should therefore be welcomed. However where there is no agreement is in how it should be measured and CPIH definitely has issues. As is often the case with statistics, there are conflicting views on how the numbers should be compiled because of the difference in the way different stakeholders perceive them and want to use them.

It probably should be remembered that the most important stakeholder of the inflation statistic is the general public. The initial reason the UK started monitoring inflation back in 1914 was to allow workers to know how much prices were rising so they could protect their standards of living. Today, people still need an accurate measure of how much the cost-of-living is increasing. They use these numbers to ensure wages, pensions and other contracts are correctly adjusted.
Given this audience, there are three tests that an important statistic such as inflation must pass:

  • It must be worked out using a simple method that is easy for the public to understand
  • It must have validity i.e. it measures what is claims to measure
  • It has to reliably and accurately portray the price rises actually experienced by the total population.

OOH arguably fails all of these tests and as a result, even though it now includes some elements of housing, CPIH is going to be a poor measure of headline inflation.