Will RPI-J eventually replace RPI? Fund firms have different perspectives

10th January 2013

Can a national statistician actually fudge things? This morning Jil Matheson has decided to create a new inflation measure or at least an amended version of the Retail Price Index known as RPI-J but it will run alongside the existing one.

That means that savers and pensioners who have pensions or own savings products linked to RPI can breathe a sign of relief. Their savings won’t be slowly eroded as RPI is pegged back because that isn’t happening anymore.

But what of RPI-J?  The J stands for Jevons named after English economist William Stanley Jevons. This will have an amended formula for calculating average prices which will be much closer to the CPI methodology though it will have different constituents. It should therefore be closer to CPI. To complicate things a little more another CPI will also be established – CPI-H which will include housing costs for owner occupiers.

The question is whether there any chance that RPIJ will start to be used by the Government to link to benefits, by National Savings & Investments or even by defined benefit pension schemes. The last might be a challenge to contract law certainly given that RPI will still exist.  It looks like no change for now.  So does that mean the change is merely of academic interest. Well not quite. Two big financial firms have a slightly different take.

Standard Life Investments thinks it is mostly business as usual though there is a slight chance gilts may be issued linked to CPI.

“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."

Jonathan Gibbs, Investment Director and Head of Real Returns, Standard Life Investments

Schroders however is a little more circumspect and suggests that over time RPI-J could replace RPI for inflation linked bond investors.

"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 RPI-J 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%."

Azad Zangana, European Economist at Schroders

Mindful Money's view is that everyone still needs to keep an eye on these indices. Governments are not averse to sleight of hand. Changing one link will start to put pressure on others. It may become more difficult to match assets to liabilities if assets are inflation linked to one index and liabilities to another or an amended version of it. 

The National Statistician at least does not seem to want to change the terms of many people’s inflation linked plans whatever the mathemetical inconsistencies.But this is still one to watch.


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