Bank of England governor calls into question purpose of Retail Prices Index

The governor of the Bank of England has questioned the purpose of the Retail Prices Index (RPI), saying the much-criticised rate had "known errors" and it would be better to focus on one measure of inflation.

In a House of Lords committee hearing, Mark Carney urged the Government to scrap the use of RPI on future contracts.

He said it was sensible to pick a date to begin transitioning off the measure, which is still used to determine rail fare costs, interest rates on student loans and to calculate returns on index-linked gilts.

RPI, which is prone to volatility and is no longer classed as a national statistic, tends to track higher than the Consumer Prices Index (CPI), sitting at 4.1% in December, compared with CPI's 3%.

Mr Carney's call came during a wide-ranging hearing where he defended the Bank's economic forecasts surrounding Brexit and backed business investment to pick up next year.

Speaking to the Lords Economic Affairs Committee, Mr Carney said: "There are some known errors (in RPI) acknowledged by the Office for National Statistics (ONS) and recognised by a number of external commentators, and we would share some of those views.

"Given the acknowledged challenges with RPI, the first thing would be not to further embed RPI in contracts, particularly public-service contracts."

He said "a carefully-timed transition" would be needed to push through change because of the values at stake, but said it would be better to begin indexing contracts around a single measure of inflation.

He added: "It would be helpful to just have one public-facing measure of the cost of living for consumers and at the moment we have RPI, which most would acknowledge has no merit, we have CPI, which virtually everyone recognises and is in our remit, and we have the ONS favourite CPIH, which includes housing costs."

On a possible transition away from RPI, the governor said the UK "wouldn't want to be in the same position 10 years from now"

"With these very difficult (decisions) in the end you have to pick a date and it tends to be seven, eight, 10 years down the road at which point you have transitioned," he added.

Despite calling for a shake-up, the Governor stopped short of pushing for a shift to CPIH as the single preferred measure of inflation because he believes it does not have the "track record" in place.

The Bank's 2% inflation target, which is set by the Government, currently uses CPI as its measure.

Focusing on the Bank's forecasts, Mr Carney accepted business investment had held up better than the institution had predicted following the Brexit vote, but said areas of the UK economy were still not firing at rates consistent with global economic growth of 4%.

However, he expects business investment levels to pick up again in 2019, as companies get greater certainty over Britain's divorce from the European Union.

Rebutting criticism levelled at the accuracy of the Bank's forecasts, he said: "I think in a mature discussion of the effects of the referendum and the prospects for this economy during a period of transition, which is what this economy is under, we should recognise how the forces of adjustment are affecting the economy.

"Yes, it is good news that business investment was rounded to 2% with the most recent figures.

"But business investment is not up anyway to the degree with a world economy growing at 4%, with the most supportive financial conditions in over a decade, with the strongest balance sheets in probably 25 years and huge opportunities of greater certainty.

"It is not growing to the extent at which it should. We estimate that it is four percentage points below what it otherwise would be."

While the UK economy has slowed since the Brexit vote, economic growth has defied expectations of a substantial slowdown and churned out a better-than-expected performance in the fourth quarter of 2017 at 0.5%.

Mr Carney said the impact of the Brexit-hit pound on inflation had "further to go", but predicted real wages to return to growth later this year.