RPI reforms in the pipeline

The Chancellor is consulting on proposed changes to the Retail Prices Index before making a decision on whether the index should be aligned with the Consumer Prices Index.

Background

The Retail Prices Index (RPI) is the oldest measure of inflation in the UK. However, the means by which the index is calculated do not meet current international statistical standards. Accordingly, in 2013 the RPI lost its status as a national statistic. The Consumer Prices Index (CPI) was put forward as the recommended measure of inflation to use in place of the RPI. A variant of the CPI, CPIH (which includes owner occupiers’ housing costs) has been the Office of National Statistics’ (ONS) lead measure of inflation since March 2017.

However, the RPI remains widely used by both the government and the private sector. It is still published monthly although the methods used to compile the index have been frozen since 2013. One of the reasons for the continuing popularity of the RPI is that it tends to outperform the CPI. Since 2010 it has produced a rate of inflation roughly 1% higher than the CPI.

ONS’ proposals

The ONS put forward two proposals for consideration by the Chancellor of the Exchequer. The first was to abolish the RPI. The second was to align the RPI with CPIH. Among the recent Budget announcements, the Chancellor indicated that he was not in favour of abolishing RPI but that he would consult on the proposed alignment with CPIH. Any changes to the method of calculating the RPI require the Chancellor’s consent as the RPI is used to calculate the rate of return on some government gilts. A fundamental change to RPI gives rise to rights to redeem those gilts.

The Chancellor has therefore issued a consultation on the proposed changes. Given the scope of the Chancellor’s role, the only area where he can take the consultation responses into account is where they have an impact on the gilts market. The main questions in the consultation are on the highly technical statistical processes to be used to align the RPI to the CPIH and the timing of the proposed changes, likely to be between 2025 and 2030. Although the consultation calls for evidence of the use of the RPI in other areas and the likely impact of the proposed changes, the consultation document cautions that these responses “are likely to be outside of scope of the potential decisions by … the Chancellor”.

Overall impact of the changes

If the changes proceed, the RPI will be calculated using the same methodology as the CPIH. The two indices will therefore increase by the same amount month by month. Because of the way that changes are likely to be introduced, for the first 12 months, the annual rate of increase will differ. After 12 months, the annual rate of increase shown by the RPI and the CPIH will be identical. The ONS has also indicated that, when the changes are introduced, it will no longer be possible to publish the sub-indices derived from the RPI. Only the “All Items” RPI will remain.

Impact on real estate

The RPI is mainly used in real estate transactions for index-linked rent reviews, index-linked service charge caps and for re-basing a purchase price when calculating overage.

Where there are existing provisions that use the RPI, the proposed changes will most likely result in a lower overall increase in the indexed amount. RPI increases currently tend to be higher than CPI increases by 1%. Where, say, a landlord deliberately chose to use the RPI over the CPIH to take advantage of the higher level of increases, the landlord will be concerned if the expected rate of increase in rents or service charge caps falls as a result of the changes.

Many index-linked clauses in real estate documents contain provisions allowing reasonable adjustments to the RPI figures or to substitute an alternative index if there are fundamental changes in the methods used to calculate the RPI. Landlords might consider whether these provisions can be used to maintain the increases that they had anticipated. Tenants looking forward to lower year-on-year increases may challenge attempts to exercise adjustment clauses. There will be plenty of scope for dispute.

Where new transactions are being entered into, the parties should consider whether the time has now come to change from the RPI to the CPIH. To reflect the current trend for the RPI to outperform the CPIH, index linked rent reviews could provide for an annual increase by CPIH + 1% rather than by RPI. Alternatively, different index could be used for calculating increases. Ideally, any index used should be published monthly and be available without charge to those who need to check the figures that have been used.

The consultation paper can be viewed here. Responses are required by 22 April 2020.