RPI inflation

It’s been announced that following a consultation on options for improving the Retail Prices Index  (RPI), the conclusion been reached by the National Statistician, Jil Matheson, that the formula used to produce the RPI does not meet international standards and it’s recommended that a new index be published.

As we know, the National Statistician’s consultation was prompted by the need to address the gap between the estimates produced by the RPI and the Consumer Prices Index (CPI). The Office for National Statistics (ONS) research programme found that use of the arithmetic formulation (known as the ‘Carli’ index formula) in the RPI is the primary source of the formula effect difference between the RPI and the CPI, and that this formulation does not meet current international standards. Their answer is to create a new RPI-based index, which will be published from March 2013 using a geometric formulation (Jevons), known as RPIJ.

In developing the recommendations, the National Statistician also noted that there is significant value to users in maintaining the continuity of the existing RPI’s long time series without major change, so that it may continue to be used for long-term indexation and for index-linked gilts and bonds in accordance with user expectations.

The National Statistician has also recommended that improvements to the measurement of private housing rents from using an alternative data source should be implemented in the February 2013 RPI indices (published on 19 March 2013). As this change affects the RPI it is subject to consultation with the Bank of England and, if necessary, the consent of the Chancellor of the Exchequer.

The Board of the UK Statistics Authority has accepted these three recommendations. The Office for National Statistics will continue to pursue its research programme in the area of consumer price statistics and work with users to maintain the quality of its consumer price statistics.

Maintaining the current RPI arrangements is good news for those with pensions linked to that index and for investors in index linked gilts.

But looking forward the gilt market will likely want to price in the risks associated with possible policy change when Mr Carney takes the helm at the Bank of England. This suggests that the trend of yield spreads – the steepness of the curve – and breakevens against index linked issues is up.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla