The government and the UK Statistics Authority (UKSA), have published their response to the consultation launched earlier this year on reform to the Retail Price Index (RPI) Methodology, following the Spending Review 2020.

The consultation proposed the continued existence of RPI, but suggested the adoption of a changed methodology seeking to align the RPI more closely with the CPIH (the Consumer Prices Index including owner occupiers' housing costs) so that increases would be the same.

However, the proposal requires the Chancellor's consent as RPI is used in two specific index-linked government gilts. The Chancellor has announced that although he sees the "statistical arguments of UKSA's intended approach to reform", in order to minimise impact on the holders of those gilts, he is unable to consent to the implementation of changes to the methodology before 2030 (which is the final maturity date of the relevant index- linked gilts). This means that the earliest the proposed changes can legally and practically be made by UKSA will therefore be February 2030. The change, when it happens, will bring the methods and data sources of the Consumer Prices Index (including owner occupiers’ housing costs (CPIH)) into the RPI. The CPIH gives a lower measure of inflation than RPI with CPIH having been around 1% lower per year on average over the past decade. This means that RPI inflation can be expected to be lower from 2030 than it would otherwise have been.

PERCEIVED FLAW OF RPI

It has long been recognised that there were shortcomings in the composition of RPI meaning it did not accurately reflect the rate of inflation.

"We have been clear that the RPI is not a good measure, at times significantly overestimating inflation and at other times underestimating it, and have consistently urged all in government and the private sector to stop using it." Sir David Norgrove, Chair of UKSA

RECAP OF THE ALTERNATIVE INDICES

RPI

RETAIL PRICES INDEX

It is calculated and published by the Office of National Statistics (ONS) but it is an older measure of inflation. It is not considered the official UK inflation rate for statistical purposes. It is still published because it is used to calculate the cost of living and wage increases and there are government indexed-linked securities and gilts.

CPI

CONSUMER PRICES INDEX

It is one of the most frequently used statistics for identifying periods of inflation or deflation. Changes in the CPI are used to assess price changes associated with the cost of living: it measures the average change in costs of purchasing a typical 'basket' of goods and services over a period of time in a typical household.

The Institute for Fiscal Studies published a report on 14 April 2020 detailing how COVID-19 could change the way countries measure CPI. The report details how consumer behaviour has changed as a consequence of the coronavirus pandemic and certain items normally included in the ‘basket’, for example package holidays and meals out, have not been available.

CPIH

Consumer Prices Index including owner occupiers' housing costs.

See: Inflation and price indices

PRACTICAL IMPACT ON REAL ESTATE

In real estate transactions, RPI can be used to measure increases in rent, payments and contract values. Service charge caps can be index-linked by reference to RPI.

When the formulae used to calculate the RPI are altered to bring the index more in line with the CPI, the likely practical effect of such a change will be to reduce the increases in rent where they are linked to increases in the RPI. The CPIH gives a lower measure of inflation than RPI with CPIH having been around 1% lower per year on average over the past decade. This means that RPI inflation can be expected to be lower from 2030 than it would otherwise have been. Parties who have negotiated clauses in the expectation that the RPI would give a greater return will not welcome this change. Landlords may wish to address the issue in lease negotiations now by referring to CPIH plus 1.

Existing contracts and leases may contain drafting which seeks to preserve the original method of computation even after a material change in the RPI methodology or will contain a substitute provision if RPI is replaced or changed. It will be interesting to see how such clauses will operate in practice and whether the continued use of RPI is contested or accepted.

In the meantime, when thinking about entering into new index-linked deals, factor in time to consider the appropriate index to which it is appropriate to refer if the term of the contract will extend beyond February 2030 (when it appears likely that the change will be implemented). Existing leases should contain a substitute provision if RPI is replaced or changed but the parties need to acknowledge in longer leases that indices are as much political as mathematical and might not do the job the parties' originally intended.