New inflation measure proposed

Receipt and money The new measure would have risen even more slowly than CPI during the past four years.

A new measure of inflation is being proposed by the Office for National Statistics (ONS).

It wants to create a version of the Consumer Prices Index that includes housing costs, to be called CPIH.

The ONS wants to counteract criticisms that the main weakness of the CPI is that it does not reflect many costs of being a house owner, which make up 10% of people's average spending.

A consultation is underway until the end of August.

If the plan is agreed by the UK Statistics Authority (UKSA), the ONS intends to publish the new measure as of February 2013.

If approved, CPIH will be published alongside the traditional Retail Prices Index (RPI) and the current CPI, which has been the government's preferred measure of inflation since 2003.

The ONS said it would be up to the government to decide if the Bank of England should use the new measure as its inflation target, or to uprate pensions and benefits.

"Once established over time, ONS proposes that CPIH become the main focus of its reporting on consumer price inflation in the UK," the ONS said.

The most recent figures for April 2012 put the CPI rate at 3% and the RPI rate at 3.5%.

Measuring the cost

The biggest cost for most homeowners is the cost of repaying their mortgage.

Start Quote

This method uses the private housing rental market as a proxy measure of the costs an owner occupier incurs ”

End Quote ONS

But mortgage interest payments are not included in the CPI, nor are a variety of other costs, such as house depreciation, buildings insurance and ground rent, and house transaction costs such as estate agents' fees, survey costs and conveyancing charges.

Council tax is not included in the CPI either.

The ONS's advisory committee rejected the idea that the new measure, CPIH, should contain a direct assessment - known as the payments approach - of how much homeowners spend each month on paying for their homes.

"This method was not suitable as mortgage interest payments are directly influenced by official interest rates, which would make the new index less suitable for use as an inflation target measure, were the government to decide to do so at some point in the future," the ONS said.

Instead, the method being recommended for including housing costs in CPIH is a measure of how much it would cost someone to rent a home from a private landlord - the rental equivalence method.

"Landlords charge rents to cover the provision of shelter and the cost of repairs and maintenance of the dwelling, [so] this method uses the private housing rental market as a proxy measure of the costs an owner occupier incurs in owning and living in their own home," the ONS said.

"Effectively it answers the question, 'How much would an owner occupier need to pay to rent their own home?'" it added.

Even lower

The CPI was first created in 1996 to conform to the requirement for a standard, European-wide, measure of inflation for the purposes of European monetary union.

In 2003 it was adopted by the then Labour government as the best official estimate of inflation for the Bank of England to use when setting interest rates, replacing another measure, RPIX, which excluded mortgage interest payments.

Since its launch in the UK, CPI has usually risen more slowly than RPI and it has commonly been assumed that the absence of most housing costs from CPI was the reason for this.

But in fact, the main reason for the two indices rising at different rates is because they use different arithmetical methods for calculating average prices.

This so-called formula effect automatically builds in a slower rate of growth for CPI and contributes 0.9 percentage points to the current gap between CPI and RPI.

As for the proposed new measure, the ONS estimates that if CPIH had existed during the past four years, then it would have risen more slowly even than CPI during the whole of that period.

That is because mortgage interest costs have been at historically low and stable levels, thanks to the Bank of England pushing its bank rate down to 0.5% in early 2009.

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