The Government is braced for a backlash from pensioners and institutional investors over changes to the way inflation is measured that are expected to slash incomes but save the taxpayer at least £2.5bn a year.
Jill Matheson, the National Statistician, will on Thursday propose how the retail prices index (RPI) should in future be calculated a decision that will have major implications for the £280bn index-linked government bond market. Although the recommendation will be made independently, final approval sits with the Bank of England and ultimately the Chancellor.
Market analysts expect the statistics office to prefer a calculation that will lower RPI by 0.9 percentage points. If approved, the change would reduce the taxpayers’ annual interest bill on index-linked gilts by around £2.7bn from February, according to Barclays Research.
However, owners of government debt such as pension funds and insurers have expressed outrage about the possible reforms, warning that they could bring the government bond market “into disrepute” and set back vital infrastructure projects £40bn of which are currently financed with RPI-linked corporate bonds.
“Future (LSE: FUTR.L - news) financing appetite in this market has to be in question if existing investments are so damaged. Government’s efforts to encourage investors to increase private funding of UK infrastructure must be cognisant of the risks,” the Association for British Insurers warned.
It added that the authorities could face “protracted litigation” from investors demanding payment under the old calculation, as institutions were forced to absorb the cost of “only earning new RPI but having to pay out old RPI”. Henry Skeoch, an analyst at Barclays Research, said: “There is also a question to be asked about whether this damages the credibility of the Government among international investors.”
For pensioners whose annuities are linked to RPI, a change would mean incomes climbed more slowly than otherwise. Saga, the pensioner group, has calculated that anyone on an annual £10,000 index-linked pension today could be £40,000 worse off over 30 years under the expected reforms.
Ros Altmann, Saga’s director general, has attacked the proposals as a “dumbing down” of inflation that fails to “serve the public good” by potentially under-recording the real rate of inflation. Saga, the ABI, and insurers Axa have called for the current calculation to be left unchanged.
Despite pensioner and institutional concerns, the change would deliver savings on a raft of prices linked to RPI, from train fares to energy bills to taxes on beer and cigarettes. Markus Heider of Deutsche Bank (Xetra: 514000 - news) said the reforms could see RPI falling below 2pc in 2014 if house prices continue to stagnate providing some respite to households that have suffered from surging transport and utility bills.
Company pension schemes would also benefit as the future liabilities of final salary schemes would be reduced.
The change in the RPI calculation was proposed by the Consumer Prices Advisory Committee, which advises the statistics office, as Britain is widely considered an outlier among international peers. At issue is the equation used to calculate RPI, rather than the basket of goods itself. The main difference between RPI and the consumer prices index, which is the key inflation benchmark, is that RPI includes housing costs.
The decision will be made shortly before the Bank of England announces its interest rate decision. It is expected to hold rates at 0.5pc and leave quantitative easing unchanged at £375bn.
The Treasury declined to comment.