Inflation is how much the cost of goods and services are going up over a certain time and there are two different measures: RPI and CPI. Here we explain how each of them work and why it matters for your money.
The CPI measure of inflation was at 2.3% in April, down from 3.2% the month before. This fall in inflationdoesn’t mean that prices are falling, just that they are rising more slowly. The older RPI measure is currently at 3.3%, down from 4.1% in March.
But how do the different measures of inflation impact your finances? In this article we explain:
- How is inflation measured?
- What are the main differences between CPI and RPI?
- Will rail fares go up by RPI in 2024?
- Why is inflation going up?
- How can I protect my finances from inflation?
Read more: What 2.3% inflation means for you
How is inflation measured?
Inflation is the rate at which prices are rising over a given time.
Every month, the Office for National Statistics (ONS) looks at around 180,000 prices of 743 items that it puts into its “shopping basket” of goods. These change as our spending habits change.
- Additions in 2023 include: e-bikes, security or surveillance cameras, and frozen berries
- Removals include: digital compact cameras, spirit-based drinks, and non-chart CD albums bought in store
As each household’s spending varies, your own inflation rate will likely differ to the rate reported by the ONS. Use the ONS’ personal inflation calculator to find out how much more you’re paying this year.
The consumer price index (CPI) measure of inflation is worked out by comparing the average price of goods and services in the basket is compared with last year’s figures
The Bank of England has a CPI target of 2% from the Government, in order to keep inflation low and stable. It can attempt to curb inflation by raising interest rates.
But to make matters confusing, the UK uses several ways to measure inflation, including:
- CPI: the consumer prices index
- CPIH: the consumer prices index plus owner-occupiers’ housing costs
- RPI: the retail prices index
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What is the main difference between CPI and RPI?
The retail prices index is the older measure of inflation between the two and typically comes out highest.
In March 2024, the retail prices measure of inflation, or RPI, was higher than CPI:
- RPI – 3.3% down from 4.1% in March
- CPI – 2.3%, down from 3.2% in March
- CPIH – 3.0%, down from 3.8% in March
While all these measures of inflation use that shopping basket of goods and services and how they have changed over time, they take different approaches.
- RPI includes mortgage interest payments: this means it is “heavily influenced” by interest rates
- CPI measures take no account of housing costs: but factors in all the other goods and services
- CPIH includes housing costs but uses an approach called “rental equivalence”: this is not the mortgage payments but how much rent the householder would pay for an equivalent property
The chart below shows how the different rates of inflation have changed over the years (ONS).
Which measure of inflation do we use?
Confusingly the UK uses both measures of inflation for different things, which affect the amount of money you have in your pocket.
The differences in the inflation rates produced by these measures matter because different costs and payments for consumers are linked to them.
Here’s a list of items that are linked to RPI:
- Final salary pension payments
- Income from index-linked annuities
- Income from some index-linked bonds
- Train tickets
- Mobile phone tariffs
- Air passenger duty
- Car tax
- Tobacco duty
- Alcohol duty
- Interest on student loans
Here’s a list of items that are linked to CPI:
- State pension
- Public sector pensions
- Lifetime allowance for pensions
- Personal independence payments (which are replacing the disability living allowance)
- Attendance allowance
- Jobseeker’s allowance
- Universal credit
- Housing benefit
- Income support
- Statutory maternity and paternity pay
- Statutory sick pay
The government tends to link its own spending, such as benefits and the state pension, to the lower CPI figure. Find out more in our guide to the state pension.
Critics call this convenient “inflation shopping” where the government links expenses to lower CPI, and income-generators (like car tax) to higher RPI.
There are calls for the system to change as we explain later in this article.
Why won’t rail fares increase by RPI in 2024?
Regulated rail fares in the England usually increase on the first working day of every new year. The formula used for rise is the previous July’s RPI measure of inflation plus 1%.
For 2023, commuters would have been facing an increase of 13.3% but the government scrapped this calculation to help with the cost of living crisis. Rail fare increases for 2023 were capped at 5.9%– 6.4 percentage points below July 2022’s RPI measure of inflation.
The increase was also delayed again: the Department for Transport announced that rail fares would not go up by as much as RPI (9% in July) in 2024 – instead they have gone up 4.9%.
Regulated rail fares are those set by the government and cover about 45% of tickets including most commuter season tickets, some long distance off-peak returns and anytime tickets around major cities.
This means that 55% of ticket prices are controlled by private companies.
We have more about how to cut down on the cost of train travel including what your rights are during a strike.
What happens when inflation rises or falls?
Inflation is a measure of the cost of living: the rate at which the price of goods, such as food, and services, such as train tickets, increase over time.
High inflation
This means you can’t buy as much with the money that you have. If wages don’t rise in line with inflation then living standards fall.
Households are being asked to keep spending more money when their income doesn’t stretch as far each month.
This is what’s happening at the moment: average regular pay growth increased by 6% in the three months to March 2024, according to the latest official figures.
This is higher than the CPI inflation rate which currently stands at 2.3%, meaning workers are seeing more money in their pockets.
Low inflation
This means prices are rising slowly. This tends to be good for consumers because prices aren’t rising faster than wages.
However, if inflation is too low then it could be a sign that there isn’t enough demand for goods and services. This can be bad for companies and cause people to lose their jobs.
Stagflation
This means inflation is rising while economic growth is falling.
Stagflation is considered the worst of all worlds and often prompts central banks to increase interest rates.
We explain more about the risks of stagflation to the UK economy.
Deflation
This means prices are falling because there is very low demand for goods and services. You may be put off spending because you think things will get cheaper.
Deflation is a sign of a severe economic problem, but is also rare in developed economies like the UK.
Why have prices been rising so much?
The cost of living has been soaring over the last couple of years largely driven by high energy and food prices. A global surge in demand for goods and services after lockdowns were lifted coupled with the fallout from the war in Ukraine pushed prices higher across the world.
The UK also had to content labour shortages and border regulations associated with Brexit and being an island and needing to import a lot of the goods that we use.
CPI is currently at 2.3%. While that figure has fallen from over 10.5% in December 2022, it rose slightly in December 2023 from the previous month’s level of 3.9%.
It is important to remember that prices are not falling. A drop in the inflation figure means that prices are not rising as fast as they were the previous month.
Is inflation good or bad?
It depends. A bit of inflation can be good for the economy as it tends to encourage us to spend now if we expect prices to rise in the future. This provides companies with money to invest in their business and pay staff more.
But too much inflation means standards of living will fall because food and services get more expensive.
High inflation is also bad news for savers. This is because the interest rates paid on standard savings accounts are unlikely to beat high inflation, meaning the value of your pot becomes eroded in real terms.
Right now the lower the inflation rate, the better the news for savers.
There are plenty of easy-access savings accounts that currently beat inflation. Find out more about the relationship between inflation and interest rates.
The best way to try to beat inflation is to invest your money. We outline the best stocks and shares ISAs.
Plans to reform the inflation system
The government announced plans in November 2020 to overhaul RPI.
In 2030, RPI will be replaced with CPIH which is deemed more useful.
The move will impact how much we pay for things like:
When this changes to CPIH, it means that the cost of some goods and services won’t go up by as much.
However, it also means that members of defined benefit pension schemes could see smaller increases in their income. This because income paid to pensioners from final salary plans rise in line RPI each year as well as index-linked gilts.
A change from RPI to CPIH would be good news for some, as the cost of everyday items should rise more slowly:
Winners
- Commuters
- Graduates
Losers
- Pension savers
- Investors
Is CPI or RPI a better measure to use? The impact on pension income
Aligning RPI with the CPIH could cost investors and pensioners £96 billion, according to the Association of British Insurers.
Anyone with final-salary pension or who has bought an annuity for retirement will be hit especially hard.
The Pensions Policy Institute has calculated that the change will reduce the average man’s final salary pension by £6,000 over the length of his retirement, while the average woman will lose £8,000.
Bear in mind that the state pension rise is linked to CPI rather than RPI.
Find out about the state pension increase 2023
How changing RPI could affect your annuity
While the difference between RPI and CPIH might look small, over time it can add up to thousands of pounds in lost retirement income.
For example: John has a £10,000 annual inflation-linked annuity.
Linked to RPI: over a 20-year retirement, if RPI rose by 2.8% each year, he would receive a total income of £263,304, according to insurer Royal London.
Linked to CPIH: over a 20-year retirement, if CPIH rose by 2.8% each year, John would receive roughly £242,974 or £20,330 less.
Note: for all standard and enhanced annuities that are not linked to inflation, changing RPI wouldn’t impact those incomes as they are fixed at the point of sale.
How can I protect my finances from inflation?
When inflation is surging as it is now there are limits to what we can do to protect our finances. However, it’s still important to clean up your finances and make sure you aren’t overspending.
We outline six inflation-busting tips to make your money stretch further:
1. Avoid poorly performing savings accounts and beat the inflation rate
With inflation now at 2.3%, the top savings rates beat inflation, meaning that your cash is gaining value in real terms. But you need to be vigilant as there are plenty of paltry paying accounts out there.
Check out the top-paying accounts.
2. Invest
Any money that you can afford to tie up for at least five years should be invested. This is because it gives it the best chance of growing, particularly compared to savings accounts.
There’s no guarantee that your investments will grow higher than inflation but it gives your money a fighting chance.
How much you earn from investments will depend on the level of risk you take and the types of things you are invested in. Of course investments can always fall but if you remain invested for the long-term you should be able to ride out any market storms.
For more information, read our beginner’s guide to investing.
3. Choose the right kinds of investments
Invest in companies or sectors that tend to benefit from high inflation or those that are seen as essential, such as banks, supermarkets or firms that manufacture consumer staples.
People tend to opt for investments that are better placed to maintain or increase their value and will therefore often turn to “safe havens”, which tend to be commodities such as gold and silver. These are all assets whose prices are underpinned to some extent because supply is limited, at least over time.
Splitting investments across a range of different industries, and asset types, is one way to protect against price inflation.
4. Shop around for cheaper products and deals
When inflation is surging, it’s wise to be even more careful about what you spend on certain items.
You could ditch the expensive brands; some supermarkets offer good value without sacrificing on quality.
Take advantage of any deals too, such as loyalty card perks. For example, Tesco Clubcard can be a great way of saving money as you shop and earning points to pay for fun activities.
5. Cut unnecessary spending
It’s still important to spend money on things that you enjoy. With that said, now is the time to pay close attention to your outgoings to make sure that you aren’t spending money on anything that you aren’t using.
Take a close look at your subscriptions and memberships and consider how much you have used them over the past three months. If you’ve barely used one of your subscriptions, cancel it.
While the odd treat is important, cutting down on regular takeaways and trips to the coffee shop could help ease the burden on our stretched budgets.
6. Take advantage of tax savings
Make sure you are using an government schemes you are eligible for, such as:
- Working from home tax relief
- The marriage allowance
- Tax-free childcare
- Salary sacrifice for your pension
We have got more tips in our article on how to protect yourself from rising inflation. Also find out ten easy ways to cut your tax bill
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