March 15, 2010 11:25 pm

ONS changes inflation calculation

The national statistics body is changing the way it calculates the retail price index in a move that dramatically alters the picture of inflation painted by the measure over the course of the recession.

Beginning with inflation figures for last month, the Office for National Statistics will calculate RPI using a broader measure of mortgage interest payments than it had previously been employing.

The change comes after the original method had the effect of sharply distorting the RPI, a longstanding measure to which a range of public sector pay contracts and benefits and the state pension are tied. It will not affect historical data.

At the point of most extreme discrepancy last April, the old measure of the RPI was showing an annual rate of 1.2 per cent deflation but had the new wider measure of mortgage costs been used, the RPI would have shown annual inflation of 0.2 per cent.

The period of retail price deflation that emerged last year would have appeared much shorter and shallower had the RPI been measured using the new methodology.

Instead of eight months of falling retail prices stretching from March 2009 to October with a peak deflation rate of 1.6 per cent, the RPI would have fallen for just four months and only reached a rate of 0.5 per cent deflation.

The changes to the way retail prices are calculated will bring the measure closer into line with the consumer price index, the main measure of inflation upon which the Bank of England bases its 2 per cent inflation target.

The main difference between the RPI and CPI is that the RPI includes mortgage interest costs, council tax and some other housing costs.

Although the CPI is the main measure of inflation for policymakers, and more comparable internationally, it is viewed as deficient by some because it does not take into account the costs of housing – a key variable in the recent boom and bust.

The tweaks to the way in which the RPI is calculated could make the data more useful again after a period in which it has been widely viewed as an unreliable guide to price movements.

Until now, mortgage payments had been factored into the RPI by assuming that all borrowers with mortgages on their homes paid the average standard variable rate offered by lenders – a floating-rate mortgage that homeowners can revert to when their fixed-rate loan ends.

The new way of measuring mortgage interest costs relies on data from the Bank of England that covers a weighted average of fixed, tracker, discount, and other mortgages that make up about 90 per cent of the mortgage universe and should move more gradually.

The ONS said the change was being made “because the new rate is more representative of the mortgage rates available”.

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