Inflation: Changes to the calculation of RPI expected
Inflation: No change to RPI calculation
(about 7 hours later)
Changes to the measurement of inflation are set to be announced on Thursday, potentially cutting the income of many private sector pensioners.
There will be no change to the way the retail prices index is calculated, the Office for National Statistics (ONS) has decided.
The Office for National Statistics has been consulting since October on three possible changes to the way the retail prices index (RPI) is calculated.
After a three-month consultation, the ONS has decided not to bring the RPI more into line with the slower rising consumer prices index (CPI).
Any of the changes would ensure that RPI rose more slowly in the future.
Instead, a new additional index of inflation will be created.
That would also restrain the future income of people holding index-linked bonds and savings certificates.
However, the RPI will continue to be used for the uprating of private sector pensions and index-linked bonds.
"The RPI change could be very significant," warned Joanne Livingstone of actuaries Punter Southall.
The National Statistician, Jil Matheson, said: "There is significant value to users in maintaining the continuity of the existing RPI's long time series without major change, so that it may continue to be used for long-term indexation and for index-linked gilts and bonds."
Widening gap
The inherent gap between RPI and CPI, which runs at an average of 1.2 percentage points a year, has become increasingly dominated by the so-called "formula effect" - the result of using different methods for calculating the average price of goods and services in the economy.
The ONS has been concerned at the widening gap in the past three years between the long-standing RPI and the government's preferred alternative, the slower rising consumer prices index (CPI).
Any decision to alter the current RPI index, so that it rose more slowly, would have reduced the future pension increases of millions of private sector pensioners and cut the income of investors in index-linked government bonds and savers with index-linked savings certificates.
Part of the gap has been due to the fact that they measure different baskets of goods and services.
Decision welcomed
But the main factor is that the two measures use different arithmetical methods for calculating average prices.
The ONS decision means that from March 2013, it will publish a new version of the RPI alongside the existing one.
This has meant that since CPI was first used in the UK in 1996, it has lagged behind RPI by an average of 1.2 percentage points each year, with the "formula effect", as it is known, being responsible for about half of that.
The main difference will be that the new index will use the same formula as the CPI for calculating average prices.
Since the start of 2010, however, when the ONS altered the way in which it accounted for changes to the price of clothes, the formula effect has become stronger. It now contributes 0.9 percentage points of that 1.2 percentage point difference between RPI and CPI.
That will mean the new RPI measure will usually rise more slowly than the long established version.
The Office for Budget Responsibility (OBR) has forecast that the overall gap will widen even further in the rest of this decade, to an average of 1.4 percentage points each year.
Ros Altmann, the director general of the financial services company Saga, hailed the ONS decision as "brilliant".
'Innocuous appearance'
"Consultation responses overwhelmingly favoured no change so would be hard to ignore," she tweeted.
The ONS has been consulting on either doing nothing, or making one of three possible changes, any of which would, to a greater or lesser extent, rein in the formula effect.
"There's no right or wrong exact measure of inflation, each one has flaws."
Removing it completely, which is one option, would shrink the overall gap between RPI and CPI considerably, although the two measures would still continue to be different.
The Treasury confirmed it would continue using the RPI measure for calculating the return on both old and new index-linked bonds.
The National Association of Pension Funds has argued against any change because so many pensioners in the private sector have their annual increases linked to RPI, and would suffer if it was designed to rise more slowly in the future.
"For gilt investors, future cash flows on existing index-linked gilts will continue to be calculated by reference to RPI," said the Economic Secretary, Sajid Javid.
Ros Altmann, director general of Saga, said the ONS should concentrate its efforts on devising a bespoke inflation index for pensioners.
"The government will continue to issue new index-linked gilts linked to the RPI."
"After 30 years of retirement, someone who receives 0.6% lower inflation uprating will end up with a pension nearly 20% lower," she said.
The ONS has already decided to launch another new measure of inflation in March, to be called CPIH.
"Therefore, over time, pensioners will be able to afford less and less and pensioner poverty will increase once again."
This will be a version of the current CPI index, but adjusted to measure changes in the cost of buying and owning a home.
Others who might suffer are pensioners who have used their private pension pots to buy an index-linked pension, or annuity.
The main CPI measure excludes those costs, something which has long been seen as its major flaw.
Tom McPhail, of Hargreaves Lansdown, gave the example of a 65-year old with a £100,000 pension pot who takes an RPI-linked annuity, currently paying £3,663 a year.
How does this decision affect you? Send us your comments using the form below.
He said that after 20 years, such a person would have lost more than £9,500 if the formula effect were abolished altogether.
"This kind of change can prove to be the most damaging of stealth attacks on pensioner incomes; it appears innocuous, but over an entire retirement, it can slowly deprive pensioners of thousands of pounds," said Mr McPhail.
Insurance firms, who hold many of the £350bn of index-linked bonds, or gilts, in issue have also argued against any change, as it would reduce their future income from these investments.
Any change to gilt returns would have to be agreed by the Chancellor, George Osborne, if the governor of the Bank of England, Sir Mervyn King, felt the change was detrimental to bond holders.
Who would benefit?
The government would save between £1bn and £2bn a year in gilt interest payments, Punter Southall has suggested.
Pension schemes themselves would need to hold fewer assets if they believed that the pensions they had to pay would rise more slowly.
This would cut some scheme deficits at a stroke.
Rail travellers would see smaller increases in those regulated rail fares which are partly linked to inflation.
And current and former students, whose interest payments on their student loan debts are linked to the RPI, would also repay less.
In England, at the end of the 2011-12 financial year, they had collectively racked up student loan debts of £40bn.
