UK CPI continues to exceed average earnings growth

18th September 2012

However the subject of inflation has been in the news before the numbers are released. The coalition government seems to be using the media to float a plan that state benefits may be frozen for a couple of years rather than be uprated with inflation. Then the benefits would rise in future by average earnings rather than inflation. The reason for the freezing of benefits is obvious as it would save money that would otherwise be spent on uprating them. But the reason for using average earnings going forwards is as I shall explain in a moment rather bizarre but in recent years it would have saved some money.

This is not the first time for this government

Back in 2010 the Chancellor of the Exchequer George Osborne announced that state benefits, tax credits and public service pensions would be uprated with the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI) (which has been used to uprate universal benefits) or Rossi Index (which has been used to uprate means-tested benefits) and that such changes would start from from April 2011. The Institute for Fiscal Studies calculated that this could save a fairly substantial amount of money as the lower CPI replaced the usually higher RPI and that this would be just under £6 billion in 2014/15 and would continue to increase over time.

Interestingly the government decided to exempt the basic state pension from such a future cutback which when you consider that its argument then was that CPI was a better inflation measure and gave a better "inflation experience" was to put in politely odd to say the least! Anyway if CPI was a better inflation measure only two years ago why are there rumours of it being replaced now?

Average earnings anyone?

If average earnings is introduced as an uprating method then it is presumably because in the last couple of years or so they have risen at less than the rate of inflation. However this has not been the case in the past and it would be fair to say that the "normal" relationship was exactly the reverse. Let me illustrate this from a report by the Joseph Rowntree Foundation from 2008 i.e pre credit crunch data:

"The study assumed 2% per year annual real growth in earnings in line with recent experience."

In the credit crunch era it would have been more accurate to put a minus sign in front of that! However the Joseph Rowntree Foundation was projecting forwards from past data and accordingly used the quotation below as an example:

"For example, if the amount of Jobseeker's Allowance (or its equivalent) received by a single unemployed person had kept pace with average earnings since 1971 it would be double the value it is now."

So this whole concept opens quite a can of worms. This is illustrated by the report from the JRF which because of the change in the relationship between consumer inflation and earnings has so far proved to be the inverse of reality. However for the government to make such a proposal gives rise to plenty of questions. The largest is what will they do if and hopefully when we see growth in average earnings rise back above the inflation rate? Another change? The next issue is that having so recently told us what a good guide to inflation the CPI measure is then perhaps they will let us know what has changed here.

UK Inflation Numbers

"The Consumer Prices Index (CPI) annual inflation stands at 2.5 per cent in August 2012, down from 2.6 per cent in July

The Retail Prices Index (RPI) annual inflation stands at 2.9 per cent in August 2012, down from 3.2 per cent in July"

Let's get the troubling bit over

"The CPI rose by 0.5 per cent between July and August this year compared with a rise of 0.6 per cent a year ago."

The reason why this is troubling is simply the mathematics of it. Multiplying 0.5 by twelve would have us considering an inflation rate of 6% using simple interest. For those who are forever telling us that substantial falls in inflation are just around the corner- so far an example of a possible job for life- these are bad figures as if we look at last year's rise this was the period when inflation was accelerating towards its peak of 5.2% in September 2011. So this month should have shown a more substantial fall.

Someone has been left high and dry

From Adam Posen's interview with the Guardian on the 27th of March 2011:

"The Bank of England's leading dove has predicted that inflation will tumble to 1.5% by the middle of next year"

And for the surprisingly large number who seem to regard him as some sort of guru let me present his own words:

"They should have somebody who gets it right and not me. I am accountable for my performance"

To be fair to Adam he did deliver on his promise to leave the Monetary Policy Committee.

Why did the RPI fall by more than CPI?

Continue reading…

 

More on Mindful Money:

Do higher wages mean higher profits?

Q&A – Finding value in uncertain markets

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