The inflation-protected government bond market cheered an unexpected decision by the national statistics body not to tamper with an influential index used to measure price changes, sending yields tumbling the most in more than a quarter of a century.
The Office for National Statistics last year announced a consultation on altering the retail price index because of statistical misgivings over the methodology used to calculate large parts of the gauge.
Many investors argued vehemently against any change – given that RPI has historically been higher than the more mainstream consumer price index – but had reluctantly resigned themselves to the index calculation changing markedly. But the overwhelmingly negative response from investors swayed the ONS into shelving its plans to alter RPI, which is the reference for about £300bn of gilts.
The decision caused the biggest one-day rally in the inflation-linked gilt market since 1987, and the third biggest since the market was created in 1981, according to Barclays.
“There were smiles on a lot of faces this morning,” said Jonathan Gibbs, a fund manager at Standard Life Investments. “It’s a pragmatic decision that balances the need for an accurate inflation measure against the practical issue of changing the reference index for a vast array of assets.”
If official statisticians had recommended a change to RPI, the Treasury would have had to decide whether to follow that advice. While insiders say that the Treasury did not relish the prospect of being put in that position, officials insist that the Treasury exerted no pressure on the statisticians.
The yield of the benchmark inflation-linked gilt maturing in 2022 tumbled 33 basis points to a negative 0.96 per cent. The yield, which moves inversely to the price of a bond, is the lowest since at least 1992, when Bloomberg began collecting data on the market.
“This was a huge surprise,” said David Dyer, a fund manager at Axa Investment Managers. “You can’t argue with the statistical problems of the RPI but we’re glad it was left alone.”
Many experts were disappointed. Michael Saunders, an economist at Citigroup, said: “As often happens when reforms are subject to consultation, the small minority who stand to lose a significant amount complain vocally, while the much larger number of taxpayers who stand to receive a modest benefit . . . are not represented.”
Capital Economics, a consultancy, had estimated taxpayers could have saved up to £7bn a year by 2016-17 from eliminating the gap between RPI and CPI.
Jil Matheson, national statistician, rejected criticism that the ONS had bowed to pressure from groups such as investors. She said she had not weighed up the interests of potential winners and losers, but had decided continuity in the index was important to its users.
The status quo will reassure both local and international investors in the UK gilt market, some of whom had become concerned that the government was trying to engineer lower borrowing costs by tampering with RPI.
The UK started issuing inflation-linked bonds in 1981, and the market for inflation-protected bonds has since become the second-largest in the world, after its US counterpart.
Although domestic pension funds and insurers are the dominant holders of so-called linkers, foreign central banks and sovereign wealth funds are important and influential investors in the wider gilt market.
John Wraith, a strategist at Bank of America Merrill Lynch, estimates that the UK will sell about £160bn of gilts in the next fiscal year, of which about £35bn will be linkers.
“To do that you need a deep and loyal investor base to pick it all up,” he pointed out. “Retroactively moving the goalposts would have disillusioned many investors, not just in the linker market but the wider gilt market.”