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UK 'should issue RPI-linked debt' despite change to inflation measure

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The UK government should not stop issuing debt linked to the retail prices index (RPI), even if it adopts an amended version of the consumer prices index (CPI) as its primary inflation measure, AXA Investment Managers (AXA IM) has argued.

The manager’s comments come after the UK Statistics Authority published a review of price statistics by Paul Johnson, head of the Institute for Fiscal Studies, which recommended that CPIH, a variant of CPI that accounts for owner-occupier housing costs, should be used as the main measure of inflation.

The Johnson Review also proposed that the Office of National Statistics publish yearly data that shows the change in living costs for different parts of the population, leading to concerns that a future government could come under pressure to uprate the state pension in line with a pensioner measure of indexation.

Jonathan Gardner, senior economist at Towers Watson, said the pressure on governments to increase pension benefits in line with the measure catered to retirees would be particularly pronounced in years where it was higher than the universal inflation measure.

He added: “Ultimately, moving to CPIH might not make any difference to the pension increases that schemes have to award.

“If the Bank of England successfully targeted 2% CPIH inflation instead of 2% CPI inflation, the inflation number should be the same even if it is measuring something else.”

Garner also welcomed the suggestion that the country’s Debt Management Office (DMO) could begin issuing Gilts linked to CPIH.

“However, demand would depend on clarity that statutory pension increases would continue to be based on the main national inflation measure rather than a pensioner index,” he said.

David Dyer, inflation-linked bonds manager at AXA IM, stressed that any issuance in CPIH would be a while off, as the means by which the index was calculated was still considered flawed.

He agreed that there was likely to be demand for CPIH-linked Gilts, and predicted that the DMO would not go to the market with any RPI-linked bonds that exceeded the latest current maturity date of 2068.

Richard Gibson, associate at Barnett Waddingham, noted that the DMO had consulted on CPI issuances as recently as 2011, after the UK switched its measure of indexation away from RPI, but concluded there would be little demand.

“It seems surprising this situation might have changed in a space of only four years, but CPI-linked debt would be strongly welcomed by pension schemes, which could use it to protect themselves more efficiently against inflation risk,” he said. 

Dyer’s colleague Lucy Barron, senior solutions strategist within AXA IM’s liability-driven investment team, also urged that any decision over future issuances should not be a binary one.

“Given that the majority of pension schemes also have part of their liabilities linked to RPI, and given the large supply and demand imbalance that exists already in this market as a result of long-term pension scheme demand for inflation-linked Gilts, we believe it would be preferable for CPI-linked debt to be in addition to RPI-issuance rather than fully in place of it,” she said.

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