Cash flow modelling inflation rates - what we using?
Spaniel_Sandal
Member
in General
Hi gang,
What rate of inflation (CPI) are you using in your cashflow modelling? Do you use more than one?
We currently have ours at 2.00% but we're feeling this is on the low side now with long-term inflation projections despite it being the target rate.
Do you increase wage growth with inflation or do you use a separate AWE growth rate?
Thanks in advance.
Daniel
Comments
Currently using 2.5% for inflation and wage growth, but also do a 10% inflation as a stress test.
I haven't been responsible for setting CFM assumptions for a few years last time I did was 2023 and this was my reasoning.
2.5%.
The 12-month UK CPI inflation rate for September 2022 is 10.1%; This is the latest available data according to ONS.gov.uk at the time of writing.
Our cashflow models could potentially be projecting for 30, 40, even 60/70/80 years of our client’s financial future.
While it's important that we continually review the assumptions we use in modelling, it's equally important not to make knee-jerk, reactionary changes.
Governance and central banks control is a lot better than it was in the 80s & 90s and therefore it would make sense to look at inflation since the Bank of England was made independent in 1997 and tasked with meeting the governments CPI target which is currently 2%.
This shows average down to 2.34%. Would this be a fair assumption for a long-term inflation figure? Bearing in mind that a large part of the Monetary Policy Committee’s remit is to keep inflation at 2%.
It could be argued that anything between 2% and 3% is a “reasoned and reasonable” assumption for inflation in a long-term projection.
We have elected to use 2.5% as this is slightly higher than the average over the last 25 years. The higher the inflation rate we use in the cash flow models the more cautious it will be.
For RPI, test the 30 year average 12-month increase based on quarterly data.
For CPI do the same.
Last time I did this was April 2024 and the figures were 3.3% and 2.4% respectively.
Process manual wording:
"We believe it is prudent to use assumptions in our cashflow that are reasonable, without being too cautious. Setting high inflation assumptions could lead to scenarios that show unachievable outcomes – this could lead to a feeling of helplessness in client expectations and an apathy towards doing anything.
We currently use 2.5% for CPI. This is higher than the 30-year average 12 month increase and the MPC 2% target.
We set our RPI assumption at 1% higher than CPI i.e., 3.5%"
We use the average of the last 20 years based on 1st January to 31st December with figures sourced from FE for CPI, RPI and Average Earnings.
Currently CPI is 2.92% on this measure so above the target of 2% but not outrageously so.
Thanks all, appreciate the responses!