Bank of England heading for new inflation target

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The Bank of England is likely to be asked to target a new inflation measure after an independent review commissioned by the UK Statistics Authority recommended scrapping the Consumer Prices Index (CPI) as the headline measure of price increases.

The report’s author, Paul Johnson, said CPI should be replaced by a measure of prices that includes owner occupiers’ housing costs known as CPIH. The Bank of England’s mandate currently compels the Monetary Policy Committee to keep consumer prices, as measured by CPI, rising at an annual rate of around 2 per cent over its forecast horizon. A shift to CPIH as the headline official statistical measure of inflation would put pressure on the Government to update the mandate.

"It’s not part of my remit to say what should the Bank of England be targeting, but [speaking] personally it would seem sensible to be targeting CPIH," said Mr Johnson, who is also head of the Institute for Fiscal Studies think tank.

The UK Statistics Authority, which supervises the Office for National Statistics, will consult on the proposed reform later this year but City analysts said it was likely the change would be implemented and that an overhaul of the Bank of England’s mandate would ultimately follow. Michael Saunders of Citi speculated that George Osborne could announce the shift in the target measure as early this year’s March budget.

The move would be unlikely to meet much resistance from Threadneedle Street. Andy Haldane the Bank’s chief economist told the Treasury Select Committee last year that it would be more appropriate to target a measure of inflation that reflects changes in housing costs.

The ONS’s experimental CPIH index has tracked the CPI relatively closely in recent years and both currently show a 1 per cent inflation rate for November. But CPIH’s status as a "national statistic" is currently suspended as statisticians investigate fears that it has been underestimating rises in housing costs. And Mr Johnson added that even if changes in the indexes were close today this might not always be the case. "In the long run these things may look very different," he said.

In his review Mr Johnson also redoubled pressure on the Government to stop using the statistically discredited Retail Prices Index in setting policy. "It is time for the UK government to take the next, logical step and stop using RPI in any element of the tax, benefit and regulatory systems," he said.

Mr Johnson added that where ministers continued to use RPI as a benchmark they should be required to justify their decision to the UK Statistics Authority. He also said the Government should stop issuing debt whose payments are linked to the RPI, a practice that is estimated to cost the taxpayer some £2bn in higher interest payments a year.