Inflation row as UK targets £3bn savings

 
Ben Southwood
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A PLAN to reform the way a key measure of inflation is calculated could save the government billions but wreak havoc in the gilts market and threaten pay rises and pensioners, analysts warned last night.

The Office for National Statistics is set to decide whether to improve the method it uses to compute the Retail Prices Index (RPI) – the rate used in index-linked gilts, indexed pensions, many pay settlements, train fares, cigarette tax and utility bills.
The government could save up to £3bn a year immediately, rising to £6bn per year by 2016 – a significant boost to chancellor George Osborne’s efforts to cut the UK’s deficit.

But such a fall would hammer investors in the RPI-linked gilt market – estimated to be worth some £347bn.

“Clearly the chancellor wants to reduce his borrowing costs, but I think there is a genuine danger that if the government is seen as moving the goalposts ... the market may charge a higher risk premium on investing in British government bonds,” said Jonathan Gibbs at fund manager Standard Life

The current methodology for the RPI ignores the effect of consumers choosing cheaper alternatives when prices rise – pushing the index up 0.7 per cent on average between 1989 and 2011, according to the Office for Budgetary Responsibility (OBR).

This gap has widened over the last few years, bringing the overall distortion of the index close to one percentage point, the OBR says.

The ONS will release a full consultation on potential options on 8 October. It will close in November, with recommendations due in the New Year.