Articles - The impact of the RPI Consultation is already far reaching

 By Shaun Richards

 Last week saw a decision by the UK National Statistician which will have quite an impact on financial markets in the UK. Let us take a look at it with the bold emphasis provided by myself.

 
 “Therefore, while the arithmetic formulation would not be chosen were ONS constructing a new price index, the National Statistician recommended that the formulae used at the elementary aggregate level in the RPI should remain unchanged. The Board of the UK Statistics Authority has accepted these recommendations.”

 
 You may not be aware that there had been quite a lot of pressure for there to be a change which mostly badged itself as being statistically based, as for example we heard and read a lot about flaws in the Carli index used in the RPI. Much less reported was objections made by opponents, including me, that it was only one amongst a number of flaws in our inflation statistics which we should deal with as a whole. Those of a more cynical nature must have wondered if it was mere coincidence that the inflation measure which tended to give the highest reading was selected for “improvement”.

 
 The Consequences of this
 Implicit
 There is one which I believe is very important, but has received almost no coverage. It is that the credibility of, and confidence in, UK statistics has resisted a move downwards and may even have made a step forwards. As we go forwards that may well have favourable consequences for UK investment markets such as the UK Gilt or government bond market.

 
 Let me explain why I think this in relation to how the United States measures its consumer inflation via its Consumer Price Index. If we put to one side the oddity of only covering urban areas we see that a lot of changes have been made to it in the last few decades. So what might you think? Well officially it is 1.7% as of the latest report but the US economist John Williams argues that in fact it is in excess of 5%. How? He argues that he has put back the changes made since 1990 and they make that much of a difference. It is not my purpose here to go into a long discussion on hedonics or to say that he is automatically right, but it is to say that avoiding doubt about the credibility of the numbers is important. We have just done so and hopefully the Office for National Statistics will continue its work but on both the RPI and the CPI.

 
 Explicit
 Index-Linked UK Gilts
 These were an obvious gainer from such an announcement and some of them rallied 5% after the announcement. So investors here not only had a good day but could anticipate more gains in the future from an investment which is usually the highest of the official measures of inflation.
 The UK taxpayer may not be as big a loser as many have claimed since this move. Yes coupon costs have not been lowered, but should they stay at the new higher prices the UK will find it cheaper to issue such bonds as long as they remain there.

 
 Existing savers and pensioners
 Many private-sector occupational pensions are indexed to the Retail Price Index. This can be in the form of annual increases once the pension has been taken or for those who have left a scheme, increases in its value before retirement. Much of the public sector has been moved to CPI or the Consumer Price Index well apart from the Bank of England which I guess is just forgetful!

 
 There are savers with index-linked savings with National Savings as well as some banks and building societies who will welcome the higher returns from this decision. Also index-linked annuities are indexed to the RPI and as this is a once in a lifetime decision they will be grateful that such a link did not suffer from a downgrade.

 
 Employers funding an occupational pension
 Here the future costs will be unchanged against possible expectations of a cut, as future indexation hedging costs do not fall. So no respite from this angle and pension deficits will be unchanged too.

 
 Utilities
 Many of these have contracts which refer to the Retail Price Index so that a side-effect of this move is they will be better off. It is also unfortunately true that rail fares are related to it so they unfortunately are likely to be higher in the future than they would have been proving that no choice was ever perfect.

 
 Some insurance contracts also have RPI linking.

  

 What happens next?
 Just like in the film Jaws there may yet be a shark in the water. If we look further into what was said by the National Statistician we saw this.

 
 “Therefore, a new RPI based index will be published from March 2013 using a geometric formulation (Jevons), known as RPIJ.”

 
 As you mull the concept of inflation in the number of inflation indices, you may note that over time there will no doubt be pressure for this to be used for some and maybe many purposes. As it will invariably give a lower answer we could see firms slip this into the paperwork for contracts such as index-linked annuities for example in the hope and expectation that such an unfavourable change for the end consumer will not be realised. The government is also likely to be taking a look at it as it is likely that it will also find it convenient to issue contracts which are cheaper for it, excuse me I meant one which meets “international standards”.

 
 Whilst we are discussing inflation there seems to be a fair bit in the number of Quango’s involved in this as we have the Consumer Prices Advisory Committee, the National Statistician from the UK Statistics Authority and the Office for National Statistics.
  

 About the Author

 Shaun Richards is a independent economist who studied originally at the LSE. His speciality is monetary economics and he uses it to analyse current economic trends. He started his career in the City of London in 1985 and brings his trading experience in bond, currency and derivative markets to his analysis of current economic events. Follow him on twitter @notayesmansecon