After a three-month consultation, the Office for National Statistics (ONS) has decided not to change the way that the retail price index (RPI) is calculated. A change which would have brought it more into line with the slower-rising consumer prices index had been widely anticipated. While a new additional index of inflation (RPIJ) will be created, the RPI will continue to be used as a measure for private sector pensions and index-linked bonds.
Azad Zangana, European Economist at Schroders, comments on today's decision:
"The ONS’ decision to keep the RPI methodology unchanged comes as a shock to investors. If the committee was purely focused on the statistical merits of the proposed changes, then there could have been no doubt that the RPI index methodology needs reform. This is apparent from the half-hearted apology from the ONS in its opening statement admitting to the substandard quality of the index.
The introduction of the new RPIJ index is designed to highlight the problem with the RPI index over time, and will probably eventually replace the RPI index as the key benchmark for compensating inflation linked bond investors.
For now, HM Treasury has confirmed that it will not change the use of the RPI index for linkers, which has helped bring yields down on the 10-year inflation linked gilt by around 28 basis points this morning.
In terms of our forecast, we will now revise up our RPI forecast to take into account today’s announcement. Our forecast for 2013 RPI inflation is now 3% against our previous forecast of 2.5%, while our 2014 forecast is now 3.6%, versus our previous forecast of 2.6%."
Jonathan Gibbs, Investment Director and Head of Real Returns, Standard Life Investments also made comment on today's announcement from the Office for National Statistics on how RPI is calculated:
"The decision not to change RPI has seen practicality and consistency win out over mathematical accuracy. The debate was always a clash between these two arguments, and the National Statistician has clearly taken account of the huge number of assets priced off RPI. To that extent this represents a pragmatic decision by ONS which balances practicalities with principles.
"At the margin this is positive for the UK's credit rating. Any perceived political interference in inflation measures could have had reputational effects on the UK. We have seen a small out-performance by gilts over bunds today, suggesting a little of this was priced in.
"The parallel future publication of RPI-J, which broadly equates to Option 3 in the consultation, is largely irrelevant, as no assets are priced off it and it is not expected to become a policy indicator.
"The new clarity slightly increases the chances of future issuance of gilts linked to CPI. However, with the introduction of CPI-H (which includes owner occupied housing) forthcoming, and some uncertainty over what will be the Government's preferred measure of inflation (and by extension the preferred target for the Bank of England), this seems unlikely for at least 1-2 years. Further, with many pensions already now using CPI, issuance of CPI-H linked bonds would create a mismatch between assets and liabilities, which would suggest that CPI would be the likely linking index."
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