Bloomberg News

U.K. Maintains RPI, Sparking Surge in CPI-Linked Bonds

January 10, 2013

U.K. Should Maintain RPI and Introduce New Inflation Measures

The Palace of Westminster is seen from the roof of Westminster Abbey, in London, U.K.. Photographer: Jason Alden/Bloomberg News

The U.K. will maintain its formula for calculating the retail price index, easing investor concern about changes to the measure that may have impaired payments on inflation-linked bonds. The securities surged.

The RPI has “significant value” for investors, Britain’s National Statistician Jil Matheson said today. While a new inflation index will be created to run concurrently to address problems with the gauge, the U.K. Treasury said it will continue to issue debt linked to the RPI and consider further implications of the announcement “in due course.”

A change to the formula for the inflation measure would have required an assessment by the Bank of England and possibly the approval of Chancellor of the Exchequer George Osborne. It could also have reduced government payments to investors in the 290 billion-pound ($467 billion) index-linked gilt market at a time when Osborne has pledged to narrow the budget deficit.

“It appears that the decision is made upon a reluctance to interfere with the continuity of the existing RPI and the impact this would have on the index-linked market,” said David Tinsley, an economist at BNP Paribas SA in London. “With a government needing to borrow vast quantities to finance its debts, now might not have been the time to irritate the investor community.”

U.K. 10-year inflation-linked gilts advanced, pushing the yield on the securities to a record-low minus 0.99 percent. The rate was 33 basis points lower at minus 0.97 percent as of 2:32 p.m. London time. U.K. 10-year break-even rates, the difference in yield between conventional gilts and inflation-protected securities, had their biggest intraday gain since Bloomberg began collecting the data in 1992, widening as much as 34 basis points to 300 basis points.

Option One

Today’s decision on the RPI equates with option one of four proposed by Matheson last year and follows a two-year assessment of the index.

The Office for National Statistics said today that while the current measure doesn’t meet international standards, there is value “in maintaining the continuity of the existing RPI’s long-term 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.”

“For gilt investors their future cash flows on existing index-linked gilts will continue to be calculated by reference to the RPI in accordance with the terms and conditions of those gilts,” Treasury minister Sajid Javid said.

New Index

The statistics office will introduce a new inflation index known as RPIJ to address an issue with the measurement of clothing prices in the RPI. The new index, to begin in March, will replace the so-called Carli formula with Jevons wherever it is used in the RPI.

Separately today, the Consumer Prices Advisory Committee -- the group set up to study issues with inflation indexes -- recommended that the approach for measuring housing rental prices should change. The Bank of England is being consulted on the proposed move.

The committee started examining the calculations that underpin the RPI after statisticians noted a widening difference between it and the consumer-price index, the basis for the Bank of England’s policy target, due to differences in the mathematical formulae used to calculate price changes.

Bank of England Governor Mervyn King had indicated his support for a change to the RPI. He said in November that it is based on “some rather outdated measures of index numbers which could certainly be improved.”

‘Mess Avoided’

Last year Matheson set out four approaches to address the issue, one of which would be to make no change. The second would remove Carli from the RPI for clothing prices, the third would remove Carli from all categories that use it, and the fourth would align the RPI calculations with those used in the CPI.

“The issue of a big, one-off change seems to be dead and buried,” HSBC Holdings Plc economists including Simon Wells in London said. “While RPI remains sub-optimal as a measure of inflation, today’s decision has probably avoided numerous messy legal challenges from index-linked bond holders.”

In Asia, China’s exports rose more than forecast last month, with overseas shipments increasing 14.1 percent from a year earlier, the most since May. That compared with the 5 percent median forecast in a Bloomberg News survey of economists. Aggregate financing of 1.63 trillion yuan ($262 billion), which includes bank and non-bank lending, was up from 1.27 trillion yuan a year earlier.

BOE policy makers refrained from adding further stimulus to the U.K. economy today, leaving their target for bond purchases at 375 billion pounds. The BOE also kept its benchmark interest rate at a record-low 0.5 percent.

The European Central Bank kept its benchmark rate at 0.75 percent. ECB President Mario Draghi said that the euro-area economy will slowly recover this year as the region’s bond markets stabilize after three years of turmoil.

“‘We have signs that fragmentation is being gradually repaired,’’ he said at a press conference in Frankfurt. ‘‘A gradual recovery should start” later this year as ECB measures work their way through the economy.’’

To contact the reporters on this story: Jennifer Ryan in London at jryan13@bloomberg.net; Lucy Meakin in London at lmeakin1@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net; Craig Stirling at cstirling1@bloomberg.net


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