–Bold Changes Would Cut Debt Payments, But Risk Hitting Gilt Market

By Will Wilkes

LONDON (MNI) – Potentially radical changes to the way in which the
UK Retail Price Index is calculated could generate significant savings
on the UK’s debt service payments on index-linked gilts.

The Consumer Prices Advisory Committee today published its
eagerly awaited report on possible reforms to the method by which the
RPI is calculated.

According to the documents released today, one of four options for
reform will be formally selected for recommendation later this year,
following a public consultation. The first option involves no changes;
the second would change just clothing prices; the third and fourth,
radical changes that could significantly lower RPI to nearer the CPI
level.

RPI is typically 0.5-1.0 percentage points higher than CPI, in part
due to the different formula for calculating it as well as the fact
that the index comprises a slightly different basket of goods. Many
critics as well as statisticians themselves believe that the method of
calculating RPI is outmoded.

FT journalist Chris Giles – who is a member of CPAC – believes that
the current method of working out RPI “grossly overestimates” inflation.

One analyst, Allan Monks, UK economist at JP Morgan says that he
expects the committee to recommend relatively subtle changes to the way
in which RPI is calculated.

“If the decision is ultimately put forward to the Chancellor, it
would create a further political hurdle. Rubber stamping a change would
significantly reduce the UK’s interest payments on a large portion of
government debt,” he said.

“Authorising a large redefinition of the RPI in the midst of a
European sovereign debt crisis would be risky to say the least… On the
basis of this political barrier and objections from those affected by a
shift, we think there is a good chance that changes to the RPI will be
more subtle,” he added.

But another analyst, Michael Saunders, UK economist at Citi Bank
says that he expects the CPAC committee to decide on radical changes to
the calculations to bring them more in line with the way in which CPI is
calculated and thus eliminate the “wedge” between the two indices.

Saunders detects a “radical bias” in the NS statement today on the
issue, calling for a consultation on changes.

Nomura’s Philip Rush also noted that the outside expert consulted
by CPAC recommended that a key formula used to calculate RPI be dropped.
This so-called ‘Carli’ formula accounts for a significant chunk of the
wedge between CPI and RPI.

Saunders detects a “radical bias” in the NS statement today on the
issue, calling for a consultation on changes.

“The report clearly hints that it (CPAC) favours options 3
or 4… Either option would cut RPI inflation significantly (by up to
0.88%, the full formula effect), hence generating significant savings on
debt service payments on index-linked gilts. Index-linked gilt holders
would lose out,” he said.

The changes would pose political problems for the UK authorities
as well as bringing benefits. Analysts believe that it could
significantly reduce debt interest payments at a time when the UK
authorities are struggling to meet severe fiscal targets.

Saunders puts the potential saving at stg3bn in FY2013-14.

There again, it would certainly be risky to reduce coupons on
index-linked gilts at a time when European bond markets remain so
potentially skittish.

–London newsroom 0044 207 862 7491; email:ukeditorial@marketnews.com

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