September 19, 2012 / 6:21 AM / 7 years ago

Pension returns at risk as inflation change mulled

LONDON (Reuters) - British pensioners and investors in index-linked government bonds could face lower incomes if changes go ahead to a key measure of inflation, as proposed by the Office for National Statistics on Tuesday.

A sign warns motorists to be aware of elderly people crossing a road in London in this file photo from 2005. REUTERS/files

The ONS’s Consumer Price Advisory Committee (CPAC) - a body with members from the ONS, Bank of England, Treasury, media and academia - has been considering changes to the retail price index throughout this year.

On Tuesday it stopped short of saying exactly how the RPI measure should change, but three of the four proposals it will put forward for public consultation would lead to a rate of RPI that is closer to the consumer price index measure.

Aligning the long-standing RPI more closely to the newer CPI could save cash-strapped Chancellor George Osborne 3 billion pounds a year in debt interest payments, but risks alienating bondholders.

“There is a trust issue,” Jonathan Gibbs, an investment director at fund manager Standard Life, told Reuters.

“Clearly the chancellor wants to reduce his borrowing costs, but I think there is a genuine danger that if the government is seen as moving the goalposts ... the market may charge a higher risk premium on investing in British government bonds.”

As well as being used to calculate returns on British index-linked gilts, RPI is also used to calculate annual rises for many private pensions as well as price changes in long-term rental, transport and utility contracts.

RPI has typically run 0.5-1.0 percent higher than CPI, which the Bank of England uses for its inflation target, and much of this difference reflects different calculation methods rather than any difference in the goods and services being sampled.

Gibbs said that two of the proposals - no change to RPI and a complete alignment to CPI - were unlikely to happen, but it was harder to see which of two other options would take place.

Alan Clarke, an economist at Scotiabank, a primary dealer in British government bonds, estimated that the more wide-ranging of the latter two options would save Osborne around 3 billion pounds a year, while the second would save 1 billion pounds.

In the more wide-ranging case, the average rate of RPI would fall by about 0.9 percentage points, Clarke said, adding that the tone of the ONS report suggested it would back this option.

“We thought that the outcome would be a ‘middle of the road’ option - changing just the clothing component. We are now of the view that the ONS could actually go for the nuclear option and change the rest of the RPI,” he said.

After consulting with the public, the ONS plans to produce its recommendations in January, with a view to them taking effect in March.

However, the final decision is likely to be in Osborne’s hands as he is legally required to give his blessing if - as seems likely - the changes decided upon are judged by the Bank of England to be harmful to bondholders.

The ONS continually reviews how Britain’s economic data are calculated and has been concerned since May 2011 about the gap between the two measures of inflation caused by statistical effects.

* For full details, see: here

Reporting by David Milliken and Sven Egenter; editing by Stephen Nisbet

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