Inflation – why does it matter in financial remedies?
We are living in an era of high inflation. At the time of writing, the current rate of inflation is 10.2%. This is a seismic shift from what has gone before it: between 2012 – 2020 the UK had low levels of inflation ranging from 1% – 3%, depending on what metric was used.
Although there is not unanimous agreement as to when inflation will significantly reduce to 2% – the rate of inflation targeted by the Bank of England – it is likely high inflation will persist at least in the short-medium term.
During periods of low inflation, the impact of indexation on maintenance orders is somewhat lessened. However, even assuming a relatively low inflation rate, the overall consequence is still significant.
With a fixed inflation rate of 3% and periodical payments of £1,000pcm over 5 years, the difference of indexation would be £3,710 when compared to a maintenance order that is not adjusted for inflation:
Index link: 3%
The importance of indexation is heightened during periods of high inflation. If the rate of inflation was 6%, the difference would increase to £7,645:
Index link: 6%
When the court makes a periodical payments order, it will consider whether it is appropriate to index link the rate of maintenance. There are broadly three possible options:
The rate does not increase with inflation and will remain fixed throughout the term of the order.
The rate of maintenance increases in line with the retail price index (RPI).
The rate of maintenance increases in line with the consumer price index (CPI/CPIH).
CPI v RPI
CPI and RPI are 2 different methods used to track inflation. They create a hypothetical ‘shopping basket’ of the goods frequently purchased by consumers. What is included in the basket differs depending on which metric is used.
The Office for National Statistics (ONS) has not used RPI since 2012/2013; the Bank of England has used RPI since 2003. The government has announced RPI will be phased after 2030 and it is generally not considered an accurate metric of inflation.
Although not always the case, RPI is higher than CPI. In September 2021, RPI was 12.6% and CPI was 10.1%. It is common for RPI to be at least 1 percentage point higher than CPI.
Practical points to consider
Whenever a periodical payments order is made, whether by agreement or by the court, practitioners must consider indexation
Higher rates of maintenance and/or longer terms = the greater the impact of indexation and the more important it is to consider its effect.
It should not be assumed a periodical payments order must be index linked, even in the current climate of extremely high inflation. There will be cases where a fixed rate of maintenance is appropriate.
When making a settlement proposal that provides for periodical payments, explicitly state whether the rate is fixed, or index linked. If the offer includes indexation, spell out which metric is used.
If during negotiations the issue of indexation is contested, it will often assist clients to calculate the difference of indexation versus no indexation – see table 1 and 2 above.
Given the metric has been phased out by most (but not all) institutions, RPI should be avoided, particularly if you are representing the paying party. If possible, fix the rate throughout the term.