Merryn's Blog

How to cut the debt - and inflation - at a stroke

The government could be about to lop a big chunk off RPI inflation - and its debt burden - by calculating it in the same way as CPI inflation.

We've written here in the past about the various ways the government might use to try and cut the Retail Price Index. There are all sorts of reasons why this would work for them.

First and most obviously, low inflation is better than high inflation; so the lower you can make the RPI look, the better. Second, it would make the liabilities of private sector occupational pension schemes look less bad many of their payouts are linked to RPI, so the lower RPI is expected to be, the better they look.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

However, possibly the most important reason to keep RPI down from the government's point of view is to keep the returns the Treasury has to pay out on index-linked gilts (which are linked to RPI) down.

There was a suggestion that the Treasury might deal with the high cost of index-linked bonds by starting to issue CPI-linked bonds rather than RPI-linked bonds (CPI has been about 0.7% lower than RPI over the last two decades). See last year's consultation paper on this.

Advertisement - Article continues below

But the release of minutes from a meeting of the Consumer Prices Advisory Committee (CPAC) suggests that there is now the beginning of a new plan underway to adjust the RPI formula to bring it in line with the CPI.

Peter Warburton, writing in the Halkin newsletter, notes that the committee discussed the "identification, understanding and elimination of unjustified causes" of the difference between the two measures, something which is known as the 'formula effect'. Were this to happen ie the formula effect to be eliminated and the RPI to fall near to CPI, this could, says Warburton "slice off perhaps 25% of the inflation-linked element of the return to redemption on a bond."

Ben Lord of M&G thinks it could be even more significant than that. Commenting in the FT's FTfm section earlier this week, he claims that were the RPI to be calculated on a geometric mean as the CPI is (rather then the current arithmetic mean) and that calculation was applied to all goods and services, the RPI would fall in the region of 0.9%. That, he says, would wipe off around 40% of the value of the typical linker.

The move would, Lord says, not be particularly different to the way in which the government cut the coupon on War Loans from 5% to 3.5% in 1932 (I've written about this here). It might not be an official default, but it would still be one. Is it likely? Hard to say.

The Bank of England has 80% of its pension fund in index-linked bonds, and also has the right to object to any changes it considers to be "materially detrimental" to holders of them. On the other hand, if the UK government is hoping to reduce its debt burden via inflation, having a huge proportion of its debt in instruments linked to the RPI - the highest level of inflation it calculates - really isn't very helpful at all.




How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019

Beyond the Brexit talk, the British economy isn’t doing too badly

The political Brexit pantomime aside, Britain is in pretty good shape. With near-record employment, strong wage growth and modest inflation, there is …
17 Oct 2019

Will Britain close its doors to immigrants post-Brexit?

Details have not yet been forthcoming, but Britain will soon have a new immigration policy. What will that mean for businesses and investors?
8 Feb 2020
House prices

Is the jump in house prices just a Brexit bounce, or is it more durable?

UK house prices rose sharply in January. Some of that is down to the end of Brexit uncertainty – but not all. There is a real risk that prices will ke…
7 Feb 2020

Most Popular

Silver and other precious metals

You should all own some silver. Just don’t expect it to make you rich

Silver is cool, beautiful and immensely useful. But for investors it's the most frustrating of metals. Dominic Frisby explains why you should own some…
12 Feb 2020

Money Minute Wednesday 12 February: grim times for European industry

Today's Money Minute previews industrial production in the eurozone, plus the latest from America's central bank.
12 Feb 2020
Investment strategy

The secret to avoiding being panicked out of your portfolio

With the coronavirus continuing to occupy headlines, investors still aren’t sure how to react. But the one thing you mustn’t do is panic. Tim Price ex…
11 Feb 2020

Why investors shouldn’t overlook Europe

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, tackles investor questions around Europe’s economic outlook and the conseq…
6 Nov 2019