LONDON (Reuters) - Yields on inflation-linked gilts hit a record low on Thursday after Britain’s top statistician unexpectedly rejected major changes to the Retail Price Index, a move that could have significantly cut future returns to bondholders.
Conventional fixed-rate gilts were broadly lower after a stronger than expected auction of Spanish debt drew funds out of Europe’s top-rated government bonds and into more risky debt.
The market was unmoved by the Bank of England’s decision, as widely expected, to hold fire on any further moves to bolster economic growth at a monthly policy meeting.
But the decision to hold off on any changes to RPI went flatly against the expectations of most and sent the yield on 10-year linkers down by as much as 34 basis points to a record low of -0.973 percent.
They pulled back by the middle of the session, but remained at around -0.95 percent versus a previous close of around -0.63 percent.
“This (RPI decision) is a big surprise relative to what markets had been discounting,” said Marc Ostwald, strategist with Monument Securities in London.
Jil Matheson, the government’s top statistical adviser, concluded that the RPI did not meet current international standards. But she said it would be better to create a new index rather than fundamentally change RPI, which is written into many existing contracts.
After the announcement, the Treasury said it would continue to use RPI, rather than the new RPIJ measure of inflation, to calculate payments for new index-linked government bonds.
“It seems likely that the threat of a raft of legal challenges left the ONS no option other than to make this smaller-than-expected change,” Ostwald said.
Analysts had expected changes in methodology that some said could have reduced average RPI inflation rates by as much as 0.9 percent and with it returns on index-linked paper.
There was little relief, however, for gilt markets, where yields have little prospect of falling further in the absence of more quantitative easing by the BoE. The government has regularly missed debt reduction goals and there are only tentative signs of the private sector growth that its fiscal retrenchment programme needs to succeed.
“You would have thought we’d see conventional gilts rally in sympathy (with linkers), but rather we’re back underperforming Bunds,” said Simon Peck, strategist at RBS in London.
“Going forward there are concerns over forthcoming supply, the risks of a (rating) downgrade and any fiscal noise around the time of the March budget. But it is the lack of further QE and the slightly encouraging signs from the BoE’s credit survey that are the drivers for the moment.”
After some early gains, by 1:13 p.m. the March gilt future was down 43 ticks on the day at 116.43, compared to a 33 tick fall for the equivalent Bund.
Ten-year gilt yields rose 5 basis points to 2.07 percent, while their spread over Bunds was 1 basis points wider at 56 basis points.