ONS proposes change to inflation measure - index-linked bond holders beware!

Sceptic001

Reports in today's Financial Times and Telegraph.

The key point for holders of index-linked certificates (and all other holders of RPI-linked savings) is:

Any change to the way the RPI is measured would have an effect on holders of index-linked government bonds, the gross nominal value of which was £278.6bn at the end of June. Both the coupon payments and the principal of these bonds are linked to the RPI index.
Removing the formula effect from RPI could also save the government roughly £2bn a year in the cost of servicing its debt.

For "cost of servicing its debt" read "reducing interest payments to savers". Surely this is one for MSE to take up on behalf of savers by making a submission in favour of no tinkering with the formula?

Linton

Sceptic001 wrote: »

Reports in today's Financial Times and Telegraph.

The key point for holders of index-linked certificates (and all other holders of RPI-linked savings) is:



For "cost of servicing its debt" read "reducing interest payments to savers". Surely this is one for MSE to take up on behalf of savers by making a submission in favour of no tinkering with the formula?

I dont see it as an issue of being fair or unfair to savers. Government borrowing of money is a market - they have got to offer sufficient return to attract sufficient income to meet their needs. If something less than RPI is what delivers the goods, then so be it. If RPI doesnt get the money in, then they have to offer RPI+x%.

Second point is that they cant change the Ts&Cs for existing bonds, only for new ones. So people considering new bonds simply need to assess the returns and make their decision on whether to buy or not.

Masomnia

Not sure about that Linton.

The bonds are still linked to RPI, changing the way RPI is calculated I assume doesn't break the T&Cs. It would mean lower returns, so I'd guess a sell off in the market would happen; sounds counter-productive to me.

Sceptic001

Linton wrote: »

I dont see it as an issue of being fair or unfair to savers. Government borrowing of money is a market - they have got to offer sufficient return to attract sufficient income to meet their needs. If something less than RPI is what delivers the goods, then so be it. If RPI doesnt get the money in, then they have to offer RPI+x%.

Second point is that they cant change the Ts&Cs for existing bonds, only for new ones. So people considering new bonds simply need to assess the returns and make their decision on whether to buy or not.

I think you have misunderstood the issue. If the basis of calculating RPI is changed then it affects all index-linked certificates, not just new ones.

Masomnia

Sceptic001 wrote: »

I think you have misunderstood the issue. If the basis of calculating RPI is changed then it affects all index-linked certificates, not just new ones.

I can't get on the FT article; but is it saying that they're proposing changing it to a geometric mean (like CPI) from the arithmetic one used now?

Sceptic001

Masomnia wrote: »

I can't get on the FT article; but is it saying that they're proposing changing it to a geometric mean (like CPI) from the arithmetic one used now?

The four options are:

The options developed by the National Statistician are:
i. No change – the reasons for the formula effect gap have been identified, explained and understood.
ii. Change one particular approach to averaging prices – which calculates the average of price relatives (the amount a price changes) over time for the same type of item where there is no information about precise expenditure - for a limited number of categories (for example, clothing), with options of the method to be used in its place. This would reduce but not remove the formula effect gap as some difference between the RPI and CPI formulation would remain.
iii. Change one particular approach to averaging prices – which calculates the average of price relatives over time for the same type of item where there is no information about precise expenditure - for all categories that use it, with options of the method to be used in its place. This would reduce the formula effect gap to a minimum, although some difference between the RPI and CPI formulation would remain.
iv. Change the RPI so that its formulae align fully with those used in the CPI – this would remove the formula effect gap between the RPI and CPI, though there would remain differences in estimates because of the different coverage, weights, products2 etc used in each.

http://www.ons.gov.uk/ons/guide-method/development-programmes/other-development-work/prices-development-plan/consumer-prices-development-work.html

Glen_Clark

Masomnia wrote: »

Not sure about that Linton.

The bonds are still linked to RPI, changing the way RPI is calculated I assume doesn't break the T&Cs. It would mean lower returns, so I'd guess a sell off in the market would happen; sounds counter-productive to me.

Counter productive it may be, but that doesn't seem to bother them now they are addicted to money printing.

shaunrc

Hi I am an economist that follows such matters and thought that I would pose a link to my analysis of this subject. I think that the changes that are likely to come to the RPI are a mistake and will disadvantage many people.

http://www.mindfulmoney.co.uk/wp/shaun-richards/why-are-changes-to-inflation-indices-such-as-the-retail-price-index-invariably-downwards/

Sceptic001

Thanks, shaunrc, for that very interesting link.

There is another very good analysis here: http://ftalphaville.ft.com/2012/09/18/1166061/rip-old-rpi-and-hello-a-happier-chancellor/

I realise this is a very technical issue, but frankly I am surprised that MSE forum readers who own index-linked certificates and other RPI-related savings products seem so unconcerned by a proposed change which is estimated to wipe between 0.5% and 0.9% off their annual returns. Pensioners with RPI-linked annual uprating will also be hit.

No wonder the FT article is entitled RIP (old) RPI and hello a happier Chancellor. He will be laughing all the way to the bank if he can get this change through with minimal public outcry.