LONDON (Reuters) - An expert on indexes reported that a method used to calculate Britain's RPI inflation measure - key to many pay and pension rises - should be changed as it yields overly high figures, and the statistics office began consultations on reform.
Three of the four proposals made by the Office for National Statistics in the public consultation it launched on Monday would lead to a retail price index that is closer to the consumer price index, which is typically lower. The remaining suggestion is for no change.
Aligning the long-standing RPI more closely to the newer CPI could save Chancellor George Osborne 3 billion pounds a year in debt interest payments, but it risks alienating bondholders as RPI is used to calculate returns on index-linked gilts.
Erwin Diewert, an expert in index number theory, said his most important recommendation for improving RPI, arising from research for the ONS, was to stop using an approach to averaging prices known as the Carli index. He said it had an "upward bias".
Meanwhile, the ONS said in the consultation document: "Because of the known limitations of the Carli index, it is difficult to defend based on international practice, and on certain approaches to assessing the performance of index numbers.
"Given this, the National Statistician has decided that the need to consult on a possible change was very clear, and the advice from CPAC was the same," the ONS said, referring to its Consumer Price Advisory Committee, which has been considering changes to RPI throughout this year.
RPI, which is also used to calculate some private sector annual pay settlements and rises for many private pensions, among other contracts, has typically run 0.5-1.0 percent higher than CPI.
Much of this disparity reflects different calculation methods rather than any variation in the goods and services being sampled.
"The ONS appears strongly minded to recommend a change (to RPI)," Barclays economist Simon Hayes said.
The consultation will close on November 30. The ONS plans to produce its recommendations in January.
The final decision is likely to be in Osborne's hands as he is legally required to give his blessing if the changes being proposed are judged by the Bank of England to be harmful to bondholders.
(Reporting by Olesya Dmitracova; Editing by Anthony Barker)