Mortgage interest stays in price index

The Chancellor has missed an opportunity to break the link between higher mortgage rates and higher inflation, by accepting the recommendations of the RPI Advisory Committee on changes to the headline definition of prices.

The committee, composed of 22 independent economists, last month submitted a majority report to Kenneth Clarke recommending that mortgage interest payments should stay in the retail prices index. One member issued a dissenting minority report, while several others disagreed privately with the recommendations.

Many other economists - including some working in the Treasury and the Bank of England - think it bizarre that the Government will retain the mortgage interest component as the best measure of housing costs. Geoffrey Dicks, of NatWest Markets, said: ``Itis perverse to include in your inflation measure something you increase to squeeze inflation out of the system.''

Steven Bell, chief economist at Morgan Grenfell and a former Treasury economist, said: "It is difficult to find a suitable measure of the cost of housing, but there is no sensible basis for using mortgage payments.''

The majority of committee members, however, thought it important the RPI should include the mortgage interest component of the cost of living. The index is the one used in uprating pay and benefits.

A majority also recommended introducing a new component of the cost of shelter for owner-occupiers - the depreciation cost of their property. This will give current house prices an influence on the index for the first time.

Andrew Sentance of the London Business School, one of the committee members, said: ``Reflecting the housing market is a sensible move, but it will not make a radical difference to movements in the RPI.''

Some had opposed the move as having no sound intellectual justification, but the majority backed it on pragmatic grounds.

Other changes include covering a wider range of types of mortgages, and removing more thoroughly ``over-mortgaging'', or borrowing more than needed to buy a property.

The recommendations will come into effect next month.