Relief for pensioners as changes ruled out for inflation measure

Relief for pensioners and savers (GETTY IMAGES)

Pensioners were given some welcome news today after the UK's top statistician said a key measure of inflation linked to retirement income and a raft of other investments and services should remain unchanged.

Jil Matheson, the national statistician, said that while the calculations used behind the RPI (Retail Prices Index) do not meet international standards, the index should be maintained due to its "significant value" to index-linked bond markets.

She recommended that a new index should be created from March, called RPIJ, which would use a different way of calculating the prices of goods and be closer aligned to the UK's benchmark level of inflation, the CPI (Consumer Prices Index).

There had been fears that changes to RPI calculations would see the index rise at a slower pace, which would have far-reaching implications as the index is linked to a wide variety of services and investments, from water bills and rail fares to pensions and even national debt.

There were concerns in particular for pensioners, as many annuities are linked to RPI and even a small percentage change could knock thousands of pounds off a typical 20-year retirement income.

Many private pensioners also have their annual increases linked to RPI, while returns for investors with index-linked bonds and savings certificates are likewise based on the index.

The RPI review had also attracted controversy, as any change prompting a fall in the index would have provided a boost to Chancellor George Osborne and his debt-busting plans, saving the Treasury billions of pounds a year in interest on government bonds.

"To have radically changed the traditional inflation measure, on which many people's incomes depend, could have jeopardised the inflation protection inherent in many people's income arrangements," she said.

RPI is higher than CPI by 1.2% on average each year and much of this is down to the so-called "formula effect" - a gap created by the different methods used to calculate the prices of goods for CPI and RPI.

Traditionally, RPI has been higher because it includes mortgage interest payments, but as borrowing rates have been slashed in recent years, the formula effect is now the biggest factor behind the gap, accounting for a 0.9 percentage point difference between CPI and RPI on average.

Ms Matheson considered four different proposals in her review of RPI, one of which would be to cut out the formula effect completely - effectively reducing the rate of RPI by nearly a full percentage point.

While there was relief from pensioners and savers at her decision, it came as a surprise to many experts who had expected a radical change.

Philip Shaw, economist at Investec Securities, said: "We are surprised that the ONS has rejected the opportunity to fix the well-discussed flaws in the RPI and are a little dismayed that we will have yet another measure of inflation to contend with."

He said it was also surprising, given that the ONS has in the past made noticeable changes to the rate of inflation, such as the way clothing prices are calculated in 2010, which was a major reason behind the leap in the formula effect gap.

Ms Matheson has recommended making improvements to the way private housing rents are calculated for both CPI and RPI, so that a far broader range of sources is used to make it more representative.

Sajid Javid, economic secretary to the Treasury, confirmed the Government would continue to issue index-linked gilts linked to the RPI.

If the RPI had reduced, JP Morgan economist Allan Monks estimated it would have saved the Treasury between £3 billion to £4 billion in servicing its own debt.

But reduced returns on index-linked bonds would have been a blow to many investors, including more than 900,000 investors holding National Savings & Investments index-linked savings certificates.

Some might have welcomed a decrease in RPI, as train fare increases are based on the index, as are student loan repayments.

Some regulated utilities are based on RPI, such as water bills, while duty rates on alcohol, tobacco, gambling and fuel are also linked to the inflation measure.

PA