There are lots of different measures of inflation in the UK. We focus on three when producing our forecasts because they directly or indirectly drive elements of our public finances forecast.
We produce forecasts for the Consumer Prices Index (CPI inflation) and the Retail Prices Index (RPI inflation). The Government uses these measures in various ways. It has set the Bank of England’s inflation target in terms of CPI inflation. In terms of tax and spending, if the Government has not set another specific policy, CPI inflation is used in the income tax system to set the path for allowances and thresholds each year and in the social security system to uprate statutory payments for most working-age benefits while RPI inflation is used to set the path for most excise duty rates. RPI inflation also determines the amount of interest paid on index-linked government debt and the amount owed by students on loans received from government.
As well as forecasting these relatively familiar monthly inflation measures, we also need to forecast inflation at the whole economy level in order to produce a forecast for the cash size of the economy, which is the most important driver of our tax forecasts. The GDP deflator includes not only inflation related to consumer spending, but also to investment, trade and the activities of government.
The forecast process starts by thinking about CPI inflation prospects in the short and medium term, with these timeframes being approached in a different way. That provides the basis for our RPI inflation forecast (which is produced by making various adjustments to get from CPI to RPI) and is the largest component of our GDP deflator forecast (which is produced by adding on forecasts for the other components of the whole economy deflator). The adjustments needed to get from CPI to RPI also allow us to forecast RPIX inflation.