A major weakness of the official consumer prices index (CPI) is its omission of owner occupiers’ housing costs. The Office for National Statistics (ONS) publishes a companion measure, CPIH, incorporating such costs using the “rental equivalence” method, which imputes rents on owned homes based on those paid on similar properties in the rented sector. The European Commission, however, has decided to base future changes in its harmonised CPI system on the alternative “net acquisitions” method, which measures the costs of purchasing and maintaining a home. The ONS recently started publishing an owner occupiers' costs series using this method. As explained below, an inflation measure incorporating this series would have provided better signals for policy-makers than CPI or CPIH in recent years.

The first chart shows quarterly data for annual CPI and CPIH inflation since 2006. The latter has been consistently slightly lower because imputed rents are estimated by the ONS to have risen more slowly than the CPI*. The difference has averaged only 0.2 percentage points, however, so monetary policy would probably have been the same if the MPC had focused on CPIH instead of CPI inflation.

The second chart compares CPIH inflation with an alternative housing-inclusive measure incorporating the new ONS owner occupiers’ costs series based on the net acquisitions approach**. The latter series gives a significant weight – currently 26% – to house prices. The alternative measure was higher than CPI / CPIH inflation in 2006-07, lower in late 2008 and 2009, and higher again in 2010 and early 2011. A focus on this measure, in other words, would have encouraged tighter policy in 2006-07, when monetary / credit conditions were excessively loose, while suggesting greater room for easing in late 2008 as the recession was gathering pace – the MPC delayed the launch of QE until March 2009.

The alternative measure would have made a stronger case for withdrawing some policy stimulus in 2010, a change that would have tempered the 2011 inflation spike. The MPC, however, might have chosen to ignore the signal because of concern about the growth impact of the pre-announced January 2011 VAT rise and worsening Eurozone economic conditions.

The alternative measure is giving a less dovish message than CPI / CPIH inflation currently, standing at 1.8% in the third quarter of 2014 (the latest available figure) versus 1.4% in both cases. Indeed, “core” inflation (i.e. excluding energy, food, alcohol and tobacco) on the alternative basis was 2.1% in the third quarter – third chart. Reflecting recent house price strength, owner occupiers’ costs rose by an annual 4.1% in the third quarter using the net acquisitions approach versus only 1.0% on a rental equivalence basis.

*The ONS plans to implement methodological “improvements” that will raise its historical and current estimates of rental inflation. The “National Statistics” status of CPIH was temporarily withdrawn in August 2013 pending these changes.
**The alternative measure was calculated by substituting the net acquisitions series for the rental equivalence series in CPIH while maintaining the same basket weight (currently 16%).

Eurozone monetary trends are sending an increasingly positive message for economic prospects. The narrow M1 and broad M3 aggregates posted further chunky monthly gains of 1.2% and 0.7% respectively in November. Six-month growth of real M1 and M3 (i.e. deflated by seasonally-adjusted consumer prices) rose to 4.7% and 2.5% (not annualised), the fastest since 2010 and 2009 – see first chart. This pick-up reflects faster nominal monetary expansion not falling prices – the CPI edged up by 0.1% in the six months to November.

The six-month real M1 change is an excellent leading indicator of the economy: it turned negative ahead of the 2008-09 and 2011-12 recessions, resuming growth before the intervening and subsequent recoveries. The current strong pace of expansion suggests upside risk to the consensus forecast of Eurozone GDP growth of 1.1% in 2015. Real M1 is now rising more rapidly than in the UK in early 2013, ahead of major positive growth surprise.

M1 has probably been boosted by interest rate declines and an associated rise in spending intentions, reflected in an increased transactions demand for money. M3 is more supply-driven: growth continues to be supported by a large balance of payments surplus*, while bank lending to government has picked up (partly in response to the TLTROs), outflows from longer-term savings instruments into deposits have increased and private sector credit contraction has slowed – adjusted for sales and securitisation, bank loans to non-government residents rose marginally in the latest three months.

The ECB publishes a country breakdown of overnight deposits, comprising about 80% of Eurozone M1. The pick-up in Eurozone six-month real deposit growth has been driven by the periphery (i.e. Italy, Spain, Greece, Ireland and Portugal) – second chart. Of the big four economies, growth remains strongest in Spain but is now significantly higher in France and Italy than Germany – third chart.

*Basic balance, i.e. current account plus net direct / portfolio investment flows.