Consumer price indices, a brief guide: 2017

Consumer price indices are important indicators of how the UK economy is performing.

The indices are used in many ways by the government, businesses and society in general. They can affect interest rates, tax allowances, wages, state benefits, pensions, maintenance, contracts and many other payments. They also show the impact of inflation on family budgets.

This article describes the main consumer price indices in the UK and explains how they are put together. It focuses on the Consumer Prices Index including owner occupiers' housing costs (CPIH) but highlights areas where other measures differ significantly.

Consumer price inflation is the rate at which the prices of the goods and services bought by households rise or fall; it is estimated by using consumer price indices. One way to understand a price index is to think of a very large shopping basket containing all the goods and services bought by households. The price index estimates changes to the total cost of this basket. Most Office for National Statistics (ONS) price indices are published monthly.

The Consumer Prices Index including owner occupiers' housing costs (CPIH) is the most comprehensive measure of inflation. It extends the Consumer Prices Index (CPI) to include a measure of the costs associated with owning, maintaining and living in one's own home, known as owner occupiers' housing costs (OOH), along with Council Tax. Both of these are significant expenses for many households that are excluded from the CPI.

The CPI continues to be published; it is produced to international standards in line with European regulations.

The Retail Prices Index (RPI) – a long-standing measure of UK inflation – and its derivatives do not meet the required standard for designation as National Statistics. The RPI, its subcomponents and the RPIX continue to be published as they are tied to long-term contracts.

The CPIH and CPI measure a wide range of prices.

The price of cars or hi-fi equipment might fall while the price of food or petrol may rise. The indices represent the average change in prices across a wide range of consumer purchases. This is achieved by carefully recording the prices of a typical selection of products from month to month using a large sample of shops and other outlets (including the provision of goods and services via the internet) throughout the UK.

The rest of this article explains how the CPIH and CPI are compiled. The approach is very similar, although some specific differences are highlighted later in this guide.

A convenient way of thinking about the CPIH and CPI is to imagine a very large “shopping basket” full of goods and services on which people typically spend their money: from bread to ready-made meals, from the cost of a cinema seat to the price of a pint at the local pub, from a holiday in Spain to the cost of a bicycle. The content of the basket is fixed for a period of 12 months, however, as the prices of individual products vary, so does the total cost of the basket. The CPIH and CPI, as measures of that total cost, only measure price changes. If people spend more because they buy more goods this is not reflected in the index.

The quantities or “weight” of the various items in the basket are chosen to reflect their importance in the typical household budget.

In practice of course we all spend different amounts on various goods and services that show different price movements.

While no-one is “average”, it is still convenient to have summary price measures which, although they may not strictly apply to any one individual or family, will still give us a useful yardstick of the impact of inflation on our own pocket or purse.

Considerable care is taken to ensure that the shopping basket is kept up-to-date and is representative of people’s spending patterns: the places and shops we go to, the goods and services that we buy and the amounts we spend on them.

The CPIH and CPI are not “cost of living” indices, a concept that means different things to different people. To many it would suggest the changing costs of basic essentials, but in practice it would be very difficult to agree on a definition of “essentials”. The index simply indicates what we would need to spend in order to purchase the same things we bought in an earlier period, irrespective of whether particular products are “needed” or are “good for you”. For example, cigarettes are included in the index as many people buy them. However, the calculations reflect the average shopping basket and so also take account of the fact that many people do not buy tobacco.

The CPIH and CPI includes all types of household spending. There are some exceptions – savings and investments, charges for credit, betting and cash gifts – that fall outside the scope of the index. CPIH now extends the CPI to include a measure of the costs associated with owning, maintaining and living in one's own home, known as owner occupiers’ housing costs (OOH) along with Council Tax.

It is impractical and unnecessary to monitor the price of every product sold in every single shop. The prices of similar items can reasonably be assumed to move in line with one another in response to market forces. It is therefore sufficient to compile the index using prices of a large and varied sample of products in selected locations. The goods and services for which prices are recorded are called “representative items”.

The CPIH, CPI and RPI are fixed quantity price indices: specific items are chosen to represent price movements in the baskets; prices are collected for those items only (700 representative items). Their movements are taken to represent the price changes for all goods and services covered by the index, including those for which prices are not specifically monitored. There are, for example, several items in the basket covering purchases of bread – such as a large white sliced loaf and large wholemeal loaf – that are combined together to estimate the overall change in bread prices.

Around the middle of each month, price collectors record about 100,000 prices for around 520 items consisting of specified types of goods and services. The price collectors are employed by the contractor (TNS) to carry out price collection on behalf of ONS, visiting a variety of shops in around 150 locations throughout the UK. Most local shops are visited in person to collect prices at first hand, although some work is done by telephone. The price collectors go to the same shops each month, noting the prices of the same products, so that over time they compare “like with like”.

The reliability of the index depends very much on retailers’ goodwill. The information collected is treated with the strictest confidence, and no data relating to individual retailers or businesses is ever divulged or passed on to a third party.

For many goods and services it is more efficient to collect prices centrally (that is, at ONS). Information on charges such as those for football admissions, water supply, newspapers and rail fares – about 80,000 prices for 190 items in all – are obtained from central sources and used in the CPIH and CPI. Prices for some large chain stores that have national pricing policies are also collected centrally at ONS.

It is important that the index calculations are based on like-for-like comparisons, of prices each month for each of the items in the basket.

However, some brands or varieties of particular products priced at the start of the year may not be available in later months. This is common in markets where the rate of technological progress is high, as is the case with many electronic goods, or where consumer tastes change rapidly, for example, in clothing.

When particular products do disappear from the market, care is taken to ensure that replacements are of broadly comparable quality so that price comparisons are not distorted. If this is not possible, prices are adjusted to take account of the change in quality, using one of a range of techniques, from fairly simple methods, to procedures that relate the prices of goods to their features.

Explicit adjustments are made, for example, in the case of personal computers, where most replacement models are of higher quality than their predecessors. A rise in price might be accompanied by improvements in processing speed, for example. In this case, an index that did not take account of improved quality would show higher inflation than an index that does adjust for quality change.

A simpler example occurs where a manufacturer changes the size or weight of a product. For example, this has happened with the size of some confectionery products being reduced. Not adjusting for this change would result in an index showing lower inflation than an index that is adjusted for the change.

In this way, quality adjustment helps to focus the index on “underlying” price changes for a fixed basket of goods and services.

We spend more on some things than others. So we would expect, for example, a 10% increase in the price of petrol to have a much bigger impact on the CPIH or CPI than a similar rise in the price of tea. For this reason, the components of the index are “‘weighted”’ to ensure that it reflects the importance of the various items in the average shopping basket, and the amounts we spend in different regions of the country and in different types of shops.

The CPIH and CPI’s weights are based on the monetary expenditure of all private households in the UK, foreign visitors to the UK and residents of communal establishments such as nursing homes, retirement homes and university halls of residence. The weights are mainly derived from the household final monetary consumption expenditure component of the national accounts.

The weights for the RPI are derived from a number of sources but mainly from our Living Costs and Food Survey. Each year, a sample of several thousand households from all over the country keep records of their spending over the course of a fortnight. They also record details of major purchases over a longer period.

In calculating the weights for the RPI, the expenditure of certain private households are excluded. Households whose income is within the top 4% of all households, and pensioner households that derive at least three-quarters of their total income from state pensions and benefits, are excluded on the grounds that the spending of these groups is significantly different from the majority. These restrictions are designed to make the RPI more representative of the “typical household”. The RPI also excludes residents of communal establishments and foreign visitors to the UK.

It is important that the index is representative and kept up-to-date. The basket of goods and services is therefore reviewed every year, helping to ensure that the CPIH and CPI calculations more accurately reflect UK shopping and purchasing patterns.

A wide range of information is used in determining the contents of the CPIH and CPI basket, including our own surveys of household spending, external market research and feedback from the price collectors. Some changes to the basket are necessary each year due to changing markets, fashions and new products. Smart-phones and tablet PCs, for example, have been added in recent years. The basket is fixed for a period of 12 months.

The weights for the index are also changed each year to keep pace with general changes in our spending habits. Over the years people have tended to spend more of their money on electrical goods, travel and leisure while the proportion they spend on basics has fallen.

After the price data have been checked and processed, the resulting price indicators are combined. Changes in prices of the individual goods and services in the index are measured by comparing them to their levels in the previous January. These are then weighted together using the weights for the current year to produce an overall average price change. The final stage in the calculation is to link the average price changes with the figures for earlier years. Only by “chain-linking” the calculations in this way can the index:

• take account of changes in the make-up of the shopping basket from year to year

• provide like-for-like comparisons between different years – this procedure ensures that the index is not distorted when items are either removed from, or introduced into, the CPIH or CPI “shopping basket”.

This procedure ensures that the index is not distorted when items are either removed from, or introduced into the CPIH and CPI "shopping basket".

The CPIH and CPI measures price changes, not price levels. It is therefore expressed in terms of the comparison of prices relative to 2015, when the index is given a value of 100.

For example - The CPIH index for July 2017 was 103.5 indicating that £103.50 would buy the same amount of goods and services as £100.00 would have in 2015. This represents a rise in prices of 3.5% between 2015 and July 2017.

The annual rate of inflation is simply the percentage change in the latest index compared with the value recorded 12 months previously.

The CPIH and CPI reference date of 2015 is arbitrary, providing simply a convenient benchmark for comparison. The choice of date has no material effect on the measurement of price changes between one month and another. The official series for CPI started in January 1996, although estimates are available back to 1988. The official series for CPIH starts in 2005.

Compared with the CPIH and CPI, the RPI has a much longer history. The series started in 1947, and prices are expressed relative to January 1987, when the index has a value of 100.

The index always refers to the second or third Tuesday of each month. Since it can often take longer than one day to collect all the local shop prices, some of these are collected on the Monday or the Wednesday. However, certain prices, which can fluctuate markedly from day to day, always relate to the Tuesday. Centrally collected prices, with only a few exceptions, also relate to a Tuesday.

The CPIH, CPI and RPI share the same price collection dates, with the exception of prices for petrol and diesel. For the CPIH and CPI, prices are averaged over the month, based on the prices prevailing on each Monday during the month. This approach is adopted in order to comply with EU regulations.

The CPIH and CPI uses essentially the same basic price data as the RPI but differs in some important respects, most of which are described earlier in this article. The differences include:

Population base

The CPIH and CPI covers a broader population than the RPI.

Item coverage

Currently the coverage of CPIH and CPI is identical, except for the inclusion of a measure of owner occupiers’ housing costs in the first. The RPI includes certain items relating to housing costs (such as mortgage interest payments) that are not included in the CPIH and CPI. Conversely there are also some services covered by the CPIH and CPI – such as charges for financial services – which are not in the RPI.

Index methodology – formula

The CPIH and CPI mostly use the geometric mean (with some use of the arithmetic mean) whereas the RPI uses the arithmetic mean to combine prices at the first stage of aggregation.

Item coding

The CPIH and CPI structure follows a standard international classification system whereas the RPI has its own unique system.

We publish the figures each month in a statistical bulletin with accompanying detailed briefing notes, about a month after the index date. The publication dates are announced at least six months in advance. Data are also available on the time series data pages.

A detailed explanation of the methodology used in compiling the indices is given in the Consumer Price Indices Technical Manual.