September’s inflation rate is used to set public sector pension increases for the following year. In 2011 these will follow the CPI. Previously, they were linked to the retail prices index (RPI), which is 1.5% higher than CPI at 4.6%
The switch was announced in Chancellor George Osborne’s Emergency Budget earlier this year.
Both CPI and RPI measure inflation by checking a wide range of prices. The ‘basket’ used in each case differs however, which is why the two figures are not the same. Most significantly, RPI includes the cost of housing (mortgage interest payments, depreciation and council tax), while this is excluded from CPI.
Historically, CPI is normally lower than RPI. However, during 2009, as RPI ‘went negative’, this was not the case. Monitoring inflation is one of the tasks undertaken by the Bank of England. The long-term target for CPI is 2%.
In August, the Bank’s Governor, Mervyn King, wrote to Mr Osborne explaining why inflation remained higher than expected. He attributed much of the rise to oil prices, the January 2010 rise in VAT and higher import prices following the depreciation of sterling. Although he predicted a fall in inflation, Mr King reported that it was now expected to remain above the 2% target until the end of 2011.
The decision to link public sector pension rises to CPI rather than RPI was a controversial move. For 2011 it means that increases will be 1.5% lower than they might have been. September’s CPI will also be used to set benefits and tax credits, although not state pensions.
State pensions will continue to rise by the higher of RPI, earnings or 2.5%. As RPI in September was 4.6%, next year’s increase in weekly basic state pension will be £4.49, taking the total from £97.65 to £102.14. State second pension (S2P) will not rise by so much, however, as CPI will be used to determine this.
CPI, rather than RPI, will also determine the minimum increase to occupational pensions in 2011. This will impact on those with deferred final salary pensions and may also affect some people who are already receiving a pension. Not all pension schemes will switch to CPI in 2011, however, as many have rules that make specific reference to RPI.
Student loan interest rates have also been traditionally linked to RPI, although for March rather than September. From December 2008 they have moved in step with Bank of England base rate instead, however, which remains at an all-time low of 0.5%.
The formula used to calculate student loan interest rates is base rate plus 1%, or RPI if this is lower. For 2011 the rate is therefore 1.5%.
The Office for National Statistics recognises that general rates of inflation may not reflect individual expenditure and price rises. They have devised an online calculator that allows people to feed in their own spending figures and calculate a ‘personal rate’ of inflation. It also publishes other inflation measures, such as the pensioner price index.
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