The UK Statistics Authority is proposing to align the retail price index with the consumer price index including housing costs, which is expected to lower its annual rate by an average of 1 percentage point.
In a joint consultation published on Wednesday with HM Treasury, the authority said it analysed different methods to address the shortcomings of the index, but decided to bring the data sources from CPIH into RPI.
In practice this means that, from the implementation date, the RPI index values will be calculated using the same methods and data sources used for the CPIH.
Following the transition, monthly growth rates for the RPI and the CPIH will be the same, whereas annual growth rates will converge after the first year, the document stated.
Based on recent experience, this change would mean RPI will be lower, on average, by 1 percentage point a year, the authority said.
Former chancellor Sajid Javid announced the intention to merge both inflation measures in September 2019, with a consultation due in January 2020. However, in January Mr Javid announced that the consultation would be launched alongside the UK Budget in March, with a response expected before the parliamentary summer recess.
RPI generally runs at about 1 percentage point higher than CPI and is currently at 2.7 per cent, compared with 1.8 per cent for CPI. Compounded over the years, the choice of the less generous index can result in pensioners losing thousands of pounds, despite the CPI being considered a more accurate index.
Timeline yet to be decided
The long-awaited consultation, however, did not bring a definite answer to when this change would be implemented, and asks whether the change should be introduced at a date other than 2030 and, if so, when between 2025 and 2030.
This was due to the potential impact of the proposal on “the holders of index-linked gilts and potential broader impacts on the index-linked gilt market”.
A change in the RPI methodology will affect both the assets and liabilities of those holders of gilts, such as pension schemes.
“The net effect on these investors’ balance sheets is uncertain in aggregate, and will also vary by individual investor. But these changes to investors’ balance sheets may affect their future demand for gilts and wider spending and investment decisions, which in turn could impact on the public finances,” the document stated.
Winners and losers among pension schemes
David Brooks, technical director at Broadstone, noted that there did not seem to be any reference to compensation for index-linked holders for loss caused by use of a lower index in the document.
“It is very surprising that this isn’t a key part of the consultation and may worry many government bond holders. It would not be a surprise that if this line is continued, ie no compensation, that there may be court action from some government gilt holders.”
Laura McLaren, partner at Hymans Robertson, noted that unless this changes, “pension schemes hedging CPI-linked liabilities with RPI-linked assets, and individuals with RPI-linked pension benefits – who stand to see aggregate lifetime pension payments reduce by between 10-20 per cent – are likely to be amongst the biggest losers”.
Gordon Watchorn, partner at pension consultancy LCP, noted that a “pensioner who is currently age 65 could find that replacing the RPI will reduce their pension by around 10 per cent – compared to what it would have been – by the time they are in their mid-eighties”.
Ms McLaren added that on the other hand it will be good news for some employers.
“Some pension scheme sponsors that have been stuck with RPI as a measure of inflation through the so-called ‘rules lottery’ might welcome finally being able to follow suit with those schemes that have already been allowed to change benefits to be linked to CPI. However, there is likely to be lots of lobbying from groups that could lose out.”
Christopher Stiles, partner at Gowling WLG, said: "It's welcome that the government and UKSA recognise that the proposed change will have diverse consequences in the market and are seeking to deepen their understanding of this. We encourage pension trustees to ensure they understand how they and their members may be affected by this, and to engage actively with this consultation process."
The consultation is available on the UK Statistics Authority website and closes on April 22.
