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Parliament demands RPI fix to stop ‘unfair’ gilt windfalls

Parliament demands RPI fix to stop ‘unfair’ gilt windfalls

(Update) Parliament has stepped up pressure on the UK Statistics Authority (UKSA) to fix faults in the retail price index (RPI) that have led to billions of pounds of overpayments to holders of index-linked government bonds and pensioners at the expense of consumer groups such as students and rail passengers.

Gilts linked to the RPI inflation measure came up pressure, with prices falling and their their real yields - which move in the opposite direction - rising 4-5 basis points, according to Thomson Reuters. 

This followed the publication of a joint letter by Nicky Morgan MP and Lord Forsyth of Drumlean, who respectively chair the House of Commons Treasury and House of Lords Economic Affairs committees, to John Pullinger, UKSA chief executive. They urged him to seek the chancellor Philip Hammond’s approval to remove a statistical error in RPI generating a ‘£1 billion yearly windfall’ for index-linked gilt owners.

RPI was replaced by the consumer price index (CPI) as the government’s official measure of inflation in 2013 and has been repeatedly shown to overstate the cost of living. In 2015 a review by Paul Johnson, director of the Institute for Fiscal Studies, recommended that it be phased out and only used as a ‘legacy measure’.

Despite this the government has continued to ‘index shop’, as the House of Lords Economic Affairs described it in a report in January, using the lower level of CPI to uprate the benefits and state pensions it pays, while using the higher RPI rate to raise interest rates on student loans and rail fares.

In its ‘Measuring Inflation’ report the committee said the UKSA risked breaching its statutory duty to protect official statistics if it did not improve RPI.

Michael Forsyth, the financier and Conservative peer who oversaw the inquiry and report, said: ‘The authority told us they had not asked the chancellor to approve fixes to RPI because they expected he would say no. The Treasury said they could not act because no request had been submitted.

‘This is a ridiculous merry-go-round. The UK Statistics Authority should submit a request immediately, and the chancellor should consent,’ he said. 

Morgan, Conservative MP for Loughborough, added: ‘It appears grossly unfair that government formulae affecting people’s incomes, such as pensions and benefits, often use CPI, whereas formulae affecting outgoings, including student loans, often use RPI, which typically gives a higher rate of inflation.

‘The committee has previously urged the government to abandon the use of RPI, which has been de-designated as a national statistic. Failing this, the chancellor should at least consent to UKSA correcting the known errors in the RPI formula.’

Index-linked gilts – whose price and interest payments rise with RPI – are highly prized by those investors who fear the UK could face a problem with higher inflation due to the Bank of England’s extraordinary loose monetary policies after the 2008 financial crisis and also to the more recent slide in the pound from Brexit.

Pension funds and defensive investment funds that prioritise capital protection, such as Capital Gearing Trust (CGT), Personal Assets (PNL) and Ruffer Investment Company (RICA), have been big buyers of UK ‘linkers’, although in recent years they have favoured their US index-linked government bonds for offering better value.

According to the Bank of England’s latest quarterly Inflation Report published last week, index-linked gilt prices fell last month in response to the House of Lords report recommending that the RPI inflation rate be lowered.

Long-dated 'linkers' are the most vulnerable. Last month M&G said the price of the 20168 index-linked gilt could fall by as much as 25%.

And Ruffer has warned that changing the terms of RPI-linked gilts would be badly received by investors and could be viewed as the UK defaulting on its debt obligations.

‘At a time when the governor of the Bank of England is stressing that the country relies on the "kindness of strangers" to fund itself, and when the country is in the international headlights, taking actions that bring the UK as a debt issuer into disrepute will be seen as reckless at best.’

The main problem with RPI dates back to an improvement by UKSA in its collection of clothing prices. Due to the 'formula effect' - which is the difference between the way RPI and CPI calculate averages - this led to the gap between the two rates widening from 0.5% to 0.8% in 2010.

According to the Economics Affairs Committee, the 0.3% increase in RPI generated lifted interest payments to index-linked bond holders by around £1 billion a year, an overpayment it now believes should be corrected.   



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