An inflationary lesson for young and old

For many, the first sign of old age is when policemen start to look younger. For financial journalists, though, it’s when statisticians start to sound far too young. And it certainly seems to me that those at the Office for National Statistics must be teenagers. How else could they decide that the basket of goods used to calculate the retail prices index (RPI) should be weighed down with MP4 players, Blu-ray discs, and internet-based DVD subscriptions?

These statistical striplings claim that MP4 players (devices that play video as well as audio, apparently) have “become increasingly popular and replace MP3 players” on the average shopping list, while renting Blu-ray discs via a website “reflects changes in the location at which services are provided”. But how many MP4 outlets and Blu-ray rental websites have you visited in the past month? To me, the real giveaway is that the stats adolescents say they’ve removed “the large ‘party size’ bottle of cider” from the basket, but have snuck in “smaller bottles for individual consumption”. Presumably at a bus shelter. In a hoodie.

So, based on this basket, RPI inflation is supposedly 0 per cent – for all of us. Perversely, if we all owned Apple iPhones, which are MP4 players, we could download the Spendometer application from financial education website Moneybasics.co.uk and check our outgoings precisely. But we don’t. So we can’t.

Fortunately, older, wiser heads have since provided some more meaningful statistics. The Institute for Public Policy Research (IPPR) said RPI could fall as low as -3 per cent by autumn but pointed out that “this is not a general deflation”, rather one due to mortgage rates. The Institute of Fiscal Studies calculated actual inflation rates for different age groups and income bands, and showed that inflation is very much a reality for anyone over 50, or not in the richest 3 deciles – reaching 6 per cent for older pensioners. Alliance Trust even rebalanced the basket of goods to reflect true spending, and found that inflation is 75 per cent higher for older consumers spending on food and bills rather than “discretionary” audio-visual goods and clothing. It argued that this disparity was a serious concern for older savers “suffering from the impact of falling interest rates.”

But it’s not just savings income that is wiped out by “hidden” inflation – it’s pensions, too. The IPPR said: “As long as the -3 per cent inflation rate is ignored by the Government when deciding the indexation of pensions, implications for the economy are likely to be limited.”

What if it isn’t ignored, though – by government or company pension schemes?

Pension consultants Watson Wyatt warned on Wednesday that “RPI uncertainty still hangs over pension schemes”. That’s because, with RPI at 0 per cent, it will require a 3.3 per cent rise in prices between now and September to prevent a negative inflation figure being recorded on the date used to calculate pension increases. If official inflation is negative in September 2009 – as most predict it will be – pensions will stay flat in cash terms. Watson Wyatt argues that pension income will technically rise relative to deflating prices. But try telling that to a 65-year-old experiencing price hikes close to 4 per cent.

Pension scheme rules may even permit, or require, trustees to reduce pensions if inflation turns negative. “Tax rules make it unlikely,” says consultant John Ball, “but there is still a question about whether one year’s deflation can be used to cancel out the next year’s pension increases. If the scheme rules say this should happen, cost- conscious employers might not volunteer to pay for increases.”

An even more cost- conscious government might not volunteer any increase to state or public-sector pensions, either. This week’s failed auction of long-dated gilts demonstrated investors’ unwillingness to back the UK’s deteriorating public finances. But, as with inflation, the official figures don’t even reveal the extent of the pension problem,
said Shore Capital on the same day. In a report, UK Debt Vortex Risk, the investment banking group pointed out that “the seemingly-modest ratio of outstanding debt to GDP provides scant comfort at best, because it excludes major off-balance-sheet obligations such as PFI and public sector pensions”.

It therefore advised “an extremely selective approach to UK investments”, recommending overseas earners such as oil and pharmaceuticals companies, and non-discretionary sectors such as utilities and food retailers.

If even junior statisticians end up as their unwilling customers in old age, there’s certainly a logic to investing in them now.

matthew.vincent@ft.com