Gilt yields dive to record lows on RPI decision

Ben Southwood
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ATION-LINKED gilt yields plunged to record lows after markets were surprised by the UK statistician’s decision not to change how the retail price index (RPI) is calculated.

RPI-linked gilts maturing in 2040 plummeted to yields of minus 0.05 per cent, before rising to close to zero, having stood at just above 0.22 per cent before the announcement.

The decision – cheered by pension funds – was taken after a consultation in which 82 per cent of 406 responses came out against rejigging the formula. But the Consumer Prices Advisory Committee, tasked with making the choice, said most of these responses made no attempt to address the statistical and methodological issue and focused only on personal financial concerns.

And the decision came despite national statistician Jil Matheson’s conclusion that the RPI fails to meet international standards. The Carli formula on which the RPI’s arithmetic is based, is said to be outdated.

Growth in the consumer prices index is kept somewhere between seven tenths of and one percentage point below RPI due to its use of the Jevons formula, which, unlike the Carli method, assumes consumers switch goods when prices rise.

Pensions groups cheered the unexpected decision, as a move would have hit them with big losses through rising yields on the RPI-linked gilts they are heavily invested in – due to their much reduced capacity as an inflation hedge.

But economists derided the decision to add RPIJ – essentially RPI calculated with the Jevons formula – as adding to an already busy field, crowded with at least 23 headline indices already.


Defined contribution pension plans
Many defined contribution pension schemes have significant investments in RPI-linked gilts, whose coupon and principal would both have been adjusted more modestly if RPI had been rejigged with a formula that saw it go up slower.

UK utility companies
UK water companies and the National Grid benefit from the move – a reduced rate would have reduced the hikes in bills they would have been able to make on their popular RPI + X deals.


The government
Debt service payments would have gone down with a formula change, since index-linked gilts are tied to the RPI inflation measure.

Final salary pension schemes
Schemes whose liabilities were discounted by RPI – 60 to 80 per cent – would have seen their deficits shrink significantly.

Commuters and drivers
Rail fares and fuel duty would have gone up slower under a rejigged RPI.