The retail consumer prices index (RPI) has been branded "flawed" and a call for it to be axed as an inflation measure has been made by the Institute for Fiscal Studies (IFS) director Paul Johnson.
In an independent review of consumer prices statistics for the UK Statistics Authority, Johnson observed there is an "unhelpful proliferation of price indices". This is causing confusion and encouraging users to retain RPI.
Johnson also argued there is a strong case for adopting CPIH - which is almost identical to the consumer prices index (CPI) but includes owner occupiers' housing costs. The proposals would have a mixed impact on pension schemes.
On the surface, a move to abandon RPI seems sensible. However, the liabilities of many schemes are linked to this measure and this can be embedded in their rules. Johnson advocated an end to RPI-linked gilts in favour of CPI-linked debt, but this would be problematic for some schemes.
Barnett Waddingham associate Richard Gibson says: "If they cease issuing RPI-linked gilts then schemes who haven't hedged their risks in those areas yet are going to find it harder to get a good hedge. They're going to find it harder to access those bonds at the same prices as perhaps they have been doing to date."
Towers Watson senior economist Jonathan Gardner says some scheme rules provide leeway over which inflation measure is used. But he adds: "Many are clear that benefits are linked to RPI. It's unclear how ‘extended' the period for phasing out RPI might be: the authorities might not wait until the last RPI-linked pension has been paid out before bringing the curtain down."
Axa Investment Managers (Axa IM) senior solutions strategist for liability-driven investing (LDI) Lucy Barron warns against abandoning RPI-linked gilts altogether. She notes the large supply and demand imbalance that exists in the market as a result of long-term demand for inflation-linked gilts.
Barron says: "We believe it would be preferable for CPI-linked debt to be in addition to RPI-issuance rather than fully in place of it. Indeed, given that the demand for long dated RPI-linked hedging instruments is likely to persist, we believe that whatever the outcome of the consultation, this should not preclude issuing RPI-linked gilts in the future with a maturity beyond 2068."
Any decision to switch to CPIH may have little effect on the pension increases that schemes award, according to Gardner. He says: "If the Bank of England successfully targeted 2% CPIH inflation instead of 2% CPI inflation, the inflation number should be the same even if it is measuring something else.
"Pension liabilities would only change if the way pensions are uprated changes while the Bank's target - and likelihood of meeting it - does not."
Gardner observes that CPIH inflation has been indistinguishable from CPI in recent months too, although this could change in future.
Gibson thinks the gap between CPI and CPIH should be around 0.3%, which would still have a significant impact on scheme liabilities. However, he argues the central bank could target a different level if it switches to CPIH.
"Remember that when we moved from RPI to CPI the actual level of the target was changed in 1998. Although the target is currently 2%, there's nothing to say that 2% would have to be the level of the CPIH target. There are a few difficult things there and probably a bit more dissention between which experts you ask on exactly what the numbers should be."
Ultimately, the only snap change likely to happen is an adjustment to the methodology the statistics authority uses. Gibson adds: "That would probably be the first real thing that happened. The actual CPIH inflation targeting, if that ever happens, will be a few years down the line."
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