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September 21, 2012 5:23 pm
Pension fund holders and investors with index-linked bonds could lose out if proposals to change the way inflation is measured become reality.
This week the Office for National Statistics (ONS) suggested a series of ideas that could alter the way the retail prices index (RPI) inflation rate is calculated.
RPI is the UK’s traditional measure of inflation and despite being succeeded by the consumer price index (CPI) – introduced to meet European requirements in 1996 – it is still used to adjust a number of prices, such as train fares, water bills and the tax on beer.
It is also the measure of inflation used to calculate coupons on index-linked gilts, which are held in large quantities by pension funds.
The ONS is consulting on whether RPI should be calculated in the same way as CPI in order to reduce the “formula effect gap” that appears between the two and that reached almost 0.9 per cent in August.
In 2010, the government chose to link benefit payments to the lower CPI rather than RPI, a measure that was expected to save billions of pounds. Altering the way that RPI is calculated could also save the government more money.
Both RPI and CPI are measured using a basket of goods but the calculation methodology employed differs. Even if the calculations are aligned then the two numbers will continue to register different levels of inflation as RPI takes into account additional costs such as rent and mortgages, which aren’t represented in CPI.
If RPI falls as a result of the new calculations, investors who hold gilts, popular index-linked saving certificates from National Savings and Investments, or who save in pensions that invest in government debt are likely to lose out.
Investors holding RPI-linked investments are already feeling the effects of slowing inflation rates. In August inflation as measured by the retail price index fell from 3.2 per cent in July to 2.9 per cent.
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