On the go: The long-awaited outcome of a consultation on replacing the retail price index of inflation is set to be published on November 25, but investors have warned that the government’s timing risks violent market reactions.
A consultation on replacing the RPI was launched in April this year by the Treasury and the UK Statistics Authority. Long criticised as a measure of the cost of living, the RPI has nonetheless been the index used for the uprating of inflation-linked gilts, the vast majority of corporate bonds, and most of the liabilities owed by UK defined benefit schemes.
Previous suggestions on how to replace the measure, floated by former chancellor Sajid Javid, involved bringing the methodology for calculating the RPI in line with that of the housing variant of the consumer pricing index, known as CPIH.
Without adequate compensation for holders of RPI assets, the effect could be a loss of as much as 20 per cent of income for some pensioners, according to modelling. The RPI typically runs around one percentage point higher than the CPIH.
Meanwhile, scheme professionals have warned of arbitrary and polarised effects on DB schemes, with funding level swings of 10 percentage points either way feasible, depending on the characteristics of individual schemes.
The government has met its promise to deliver a response by autumn, but some investors are worried that its proximity to the Christmas break, when liquidity typically dries up, could cause a bumpy ride when the decision is announced.
Jos Vermeulen, head of solution design at Insight Investment, commented: “More than 10m beneficiaries of DB pension schemes in the UK will learn on November 25 if they are collectively set to lose more than £100bn as a result of the RPI reform.
“In what has already been an extremely challenging year for the public and corporates, aligning the RPI with the CPIH, as per the proposal, will cause further misery for pensioners and sponsors of pension schemes with CPI-linked liabilities.”
Mr Vermeulen suggested that markets have priced in a “very high probability” that the RPI and the CPIH will be aligned with no margin to separate them, and warned of year-end volatility in inflation markets.
“We hope that the UK government and the UKSA have given careful consideration to the economic consequences of the RPI reform before making a final decision, and that they have listened to the broad community of stakeholders who participated in the consultation process earlier this year,” he said.
