Decision on whether key inflation measure should be brought closer to CPI could have profound consequences
Changes to the way a key measure of inflation is calculated are to be announced on Thursday amid fears of a “stealth attack” on pensioners.
The Office for National Statistics (ONS) will announce the results of a review of the Retail Prices Index (RPI) as it looks at ways to reduce the gap with the official Consumer Prices Index (CPI) measure of inflation.
Any move to change RPI calculations would have far-reaching implications, with RPI linked to a wide variety of services and investments, from water bills and rail fares to pensions and even national debt.
There are growing concerns in particular for pensioners as many annuities are linked to RPI and even a small percentage change could knock thousands of pounds off a typical 20-year retirement income.
The proposals are also attracting controversy as they could provide a boost to the chancellor, George Osborne, and his debt-busting plans, saving the Treasury billions of pounds a year in interest on government bonds.
Plans under review could see changes to the way prices are calculated for goods, which is different for CPI and RPI, leading to the so-called “formula effect gap”.
Traditionally RPI has been higher because it includes mortgage interest payments, but as borrowing rates have been slashed in recent years the formula effect is now the biggest factor behind the gap, accounting for a 0.9 percentage point difference between CPI and RPI on average.
Tom McPhail, head of pensions research at Hargreaves Lansdown, said if RPI was reduced by 0.9% it would slash retirement income by more than £9,500 over 20 years on a market-leading index-linked annuity.
“This kind of change can prove to be the most damaging of stealth attacks on pensioner incomes,” he said.
“It appears innocuous but over an entire retirement it can slowly deprive pensioners of thousands of pounds.”
Changes that would lower the rate of RPI would also reduce the returns on index-linked gilts and bonds.
This would be good news for the Treasury by bringing down the cost of servicing its debt by an estimated £3bn to £4bn, JP Morgan economist Allan Monks said.
But the “less quantifiable cost is the reputational damage this does in the eyes of the international investor community”, he said, coming so soon after Osborne announced the transfer of interest payments on gilts held by the Bank of England to the Treasury.
The decision will flatter national accounts by £35bn over the next 18 months – a decision that has already been cited as an example of Osborne’s “willingness to gamble with the government’s credibility”, according to Monks.
Reduced returns on index-linked bonds would also be a blow to many investors.
Some final salary pension payments are likewise linked to RPI, while more than 900,000 investors with National Savings & Investments index-linked savings certificates would see an impact on returns.
But a reduction in the rate of RPI would be good news for some. Commuters would benefit, as train fare increases are based on RPI, and student loan repayments are also set using the index.
Some regulated utilities are also based on RPI, such as water bills, which may help limit annual increases for households, while duty rates on alcohol, tobacco, gambling and fuel are also linked to the inflation measure.
The ONS is looking at four different options, which range from doing nothing to ensuring that CPI and RPI use exactly the same calculation.
If changes to RPI are recommended, the plans will go to the Bank of England for review and ultimately the chancellor if the more radical option is proposed that will affect index-linked gilts.
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