Again from FT Alphaville:
"As UBS economist Amit Kara writes, things seem to be moving — albeit slowly:
'...the timing of the introduction of housing costs in CPI appears unclear. Our assumption is that the BoE is fully engaged in the process and that the ONS has already made considerable progress as part of a similar European project. As is often the case with major changes to statistical indices, the ONS will likely introduce the new series on an experimental basis before settling on the final methodology. The financial markets will of course respond as soon as the experimental series is introduced. Our hunch is that the experimental series is still at least twelve months away and the decision may be driven by political factors.'
As for the impact itself . . .
'Including the housing costs in the CPI removes one of the many differences that drive a wedge between CPI and RPI inflation rates (see Chart 2). The housing depreciation component in RPI is the key subcomponent that measures the cost of housing. To affirm this, Chart 3 shows the correlation of this subcomponent to nationwide house price index (in YoY terms). We estimate that since 1996, the contribution of the housing depreciation component has been on average 0.3 percentage points (pp) to RPI inflation (See Chart 4). Clearly the contribution is above or below the average in different economic cycles. Given that the average includes the sharp fall in house prices seen during the last quarter of 2008 which is less likely to be repeated in average growth years, we envisage a slightly higher contribution; say 0.35pp, of the inclusion of a housing index into CPI.
Another important contributor to the difference between RPI and CPI is the aggregation technique that has until recently added a relatively constant 0.5pp wedge between the two price indices. Most recently though (as Chart 5 shows), that gap has widened to 0.8pp (extra in RPI) – the highest since 1996. The ONS has yet to explain this development and therefore it is hard to know if it will persist, but if it does, that suggests that the gap between RPI and CPI may be wider than the average experienced so far. In other words this 0.3pp widening is similar in size to the 0.35pp narrowing that we envisage from the inclusion of housing costs in CPI; the result of course, is that the long run wedge between RPI and CPI (on an average this has been 0.86pp) could potentially remain intact even after the changes to the CPI index.'
And here — in terms of the BoE’s monetary policy — is where things get interesting:
'If our assumptions and calculations are correct and the housing component makes a positive 0.35pp contribution to the CPI index, by retaining the current target of 2.0%, the government in effect will be lowering the inflation target. All things equal, the MPC will have to hold the policy rate slightly higher than otherwise in the near term but further out, because the inflation target is lower, the equilibrium nominal interest rate will be lower than otherwise. Overall though, in the big scheme of things, the impact is likely to be negligible.'"
