UK’s RPI Inflation Measure to be Left Unchanged

The UK’s Office for National Statistics (ONS) has upset expectations by recommending that the retail price index (RPI), a key measure of inflation in the UK, remain unchanged. The UK Statistics Authority said that it accepted the recommendation, despite advice from the Consumer Prices Advisory Committee (CPAC) that the calculation of the index should be changed.

The ONS decision was seen as good news for UK and foreign investors in the £294bn UK index-linked government bond market, who were anticipating a change, but less positive for taxpayers, who will continue to fund protection against inflation on bonds that statisticians concede overstate the true rate.

The ONS consultation was prompted by a need to address the gap between the inflation estimates produced by the RPI and the UK’s slower-rising consumer prices index (CPI). The ONS research programme found that the RPI formula causes the gap and a new RPI-based index should be published from March 2013 using a new formulation known as RPIJ. However, the ONS said the existing RPI series should continue without major change to be used for long-term indexation and index-linked gilts and bonds.

“Therefore, while the arithmetic formulation [of the RPI] would not be chosen were ONS constructing a new price index, the National Statistician recommended that the formulae used at the elementary aggregate level in the RPI should remain unchanged,” the ONS said.

Glyn Bradley, an associate at consultant Mercer, commented: “The headline is ‘no change to RPI’ but in fact today’s decision is actually a positive decision to keep the significant changes accidentally introduced in 2010, although we expect the ONS to continue to investigate whether it can improve the index.

“Back then, an apparently minor technical decision was made to improve the way clothing and footwear prices were collected. However, for various statistical reasons, these changes seem to have widened the gap between CPI and RPI by around an extra half a percent per year. That sounds small but it could increase RPI-based benefits by about 10% over the course of 20 years.

“Although this will be a relief to pensioners receiving RPI-linked benefits, the flip side is that employers’ costs are higher than they might reasonably have expected. The ONS has an ongoing task of ensuring its inflation calculations are robust and we expect it will continue to investigate whether the difference between RPI and CPI can be defended.”

According to actuarial advisory firm Punter Southall, the ONS decision has dashed UK emplyers’ hopes of seeing pension deficits shrink. “Many employers will be disappointed,” said its technical director Joanne Livingstone. “Both they and the industry had expected an alteration to the calculation. One option could have shaved up to one percent off the RPI inflation rate, reducing deficits by possibly as much as 25%.

“Instead, no change means inflation expectations are now likely to rise, pushing up liabilities and deficits. It will also boost the price of inflation-linked securities like gilts and swaps. That will make it more expensive to take inflation risk off the table via a buy-out.

“As far as members are concerned, more price indices – like the proposed RPIJ – will give them more information and data but it will also lead to more questions about the degree of their cost-of-living protection.”


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