Markets surprised by ONS inflation move

 

Inflation-proofed government bonds were given a boost today after the Office for National Statistics ruled out a change in the method of calculating the retail prices index that would have slashed interest payments to investors by billions of pounds every year.

The yields of 10-year index-linked gilts – whose coupon payments are structured to protect holders from the impact of RPI inflation – fell by about 35 basis points as traders responded to the surprise move.

The ONS established a consultation two years ago on whether to change the mathematical formula for calculating the RPI. Many analysts had expected it to tweak the index this week, which would have had the effect of reducing the recorded rate of RPI inflation.

Jil Matheson, the National Statistician, admitted that the existing RPI formula does not meet international statistical standards, and said the ONS would, from March, publish a superior index called RPIJ, expected to reflect lower cost of living rises.

However, Ms Matheson added that there was "significant value" in leaving the existing RPI calculation untouched for the sake of bond holders, and continuing to publishing the index every month. The Treasury confirmed existing holders of the £350bn index-linked bonds in the market would continue to receive coupons linked to RPI.

Nevertheless, the Government failed to make a similar commitment to maintain an RPI link for a host of other policies such as the regulation of train fare increases, rises in fuel duty and student loan interest rates.

This leaves the door open for ministers to start using the lower RPIJ measure in these areas in future, potentially easing the financial squeeze on rail passengers, students and motorists by 1 per cent a year. There were signs tonight that lobby groups will press for such a shift.

"Anything that better reflects the cost of living to families should be used to calculate increases in fuel duty," Luke Bosdet, a spokesman for the AA, said. Anthony Smith, Passenger Focus's chief executive, said: "Passengers would naturally support changes to the way inflation is calculated if it means lower fare rises."

The ONS was accused by some of bowing to pressure from vested interests in reaching its decision. Some 82 per cent of respondents to the consultation – many from the financial sector – were hostile to RPI reform. "As often happens when reforms are subject to consultation, the small minority who stand to lose a significant amount complain vocally, while the much larger number of taxpayers who stand to receive a modest benefit are not represented," Michael Saunders of Citigroup said.

Elsewhere, the Bank of England kept its £375bn QE programme on pause despite rising fears of a UK triple dip.

RPI: Fit for purpose?

The retail price index (RPI) began in 1947. Though it was replaced as the primary measure of inflation by the consumer price index (CPI) in 2003, index-linked gilt returns, as well as many tax rises, are still determined by RPI. The proposal rejected by the Office for National Statistics was to improve the RPI by using a different mathematical formula. Most statisticians agree this would have better reflected rises in the cost of living.

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