If you got a 3% pay rise did your real income go up or down?

Gordon Brown announced yesterday that public sector wages will increase by 1.9% this year. Within that number nurses will get 2.5%, civil servants 2%, and soldiers 3.37% – medical consultants get just 0.59%, although that is from a base of £170,000 before you get too outraged. What I found interesting from the media comment is that not one person mentioned CPI. Every commentator has focused on RPI. This quote from the Times is typical – "On average, wages in the public sector will increase by 1.9 per cent, less than half the retail prices index inflation rate of 4.2%". For the record CPI, which is what after all, the Bank of England targets, is currently 2.7%.

The unions’ focus on the "old" inflation measure is perhaps unsurprising given that it’s higher than the "new" measure, but the fact that independent commentators have yet to accept the CPI measure as the standard will be worrying for the Monetary Policy Committee. If wages, and inflation expectations, are set around the RPI headline rate, then setting interest rates on the basis of a different (and lower) inflation measure is likely to mean that monetary policy will be kept too loose to prevent an inflationary spiral. An important part of the Bank’s job over coming months therefore must be to win hearts and minds for the CPI measure. The fact is though that whilst RPI will fall back once the housing market slows, the Bank believes it is structurally about 0.5% – 0.75% higher than CPI. So if your wages are being linked to CPI rather than RPI, you are likely to lose out over the long term. An Office of National Statistics (ONS) chart showing this can be found here.

To go back to the opening question – if you got a 3% pay rise, did your real income go up or down? Well it depends on your individual inflation rate. Is your personal basket of goods more like the CPI or the RPI? For example if you are looking to buy a first home, or a bigger home, then the RPI will be more important to you as property prices are a major factor in its calculation. The ONS did produce a Personal Inflation Calculator, but as we mentioned before you need to download an SVG viewer to use it, and that’s certainly beyond me. The question is an important one though – if real incomes are rising, then UK economic growth is likely to remain at, or above trend. If they’re falling then it’s likely to herald tough times ahead for the high street and housing market.