Private sector pensioners and many savers and investors could be hit by changes to the way an inflation measure is calculated, experts say.
The Office for National Statistics (ONS) is considering changing the way that the retail prices index (RPI) is calculated. Any change would make the RPI move more slowly, in step with the consumer prices index (CPI).The consultation period will close at the end of October, and any agreed changes will be introduced from next March. Some pension and investments experts and accountants have warned that should these changes be adopted then this would result in a substantial cut in the incomes of private pensioner’s incomes in the years to come.
The ONS believes that it may be necessary to make changes if future inflation calculation is to be more accurate and reflect the true state of the economy.
Although the ONS is independent, critics argue that any changes made by the department to bring the two price indices in line, will only be seen as a back-handed way of helping the government save money, and ratify the government’s controversial changes of 2011 which moved the rating of public sector pensions from RPI to CPI as well the uprating of benefits and tax credits.
The RPI usually rises faster than the CPI, with an average gap of 0.9 percentage points each year since CPI was first used in 1996. The reason for the gap depends on a number of different factors:
- the indices vary because they do not cover exactly the same sets of goods and services; for example, RPI reflects the cost of buying and owning a home, whereas the CPI doesn’t.
- the CPI covers the spending of all UK households, whereas the RPI excludes the spending of the wealthy, and those pensioner households who are mainly dependent on the state pension and benefits, which when taken together represents about 13% of the population.
- the two measures use different mathematical formulae to calculate the average rise in the prices of the goods and services being measured.
In August the gap was 0.4 percentage points, but in 2007 it was 2.3 percentage points. However since the start of 2010, when the ONS changed the way it measured movements in the prices of clothes, the ‘formula effect’ has become the most dominant influence. The Office for Budget Responsibility (OBR) has forecast that the overall gap between the two inflation measures will widen in the coming years, to an average of 1.4 percentage points during the rest of this decade.
The options available to the ONS are:
- no change at all;
- partial changes to the RPI’s formula, which would reduce the gap with CPI slightly;
- a change of construction of the RPI to remove the formula effect altogether, which would shrink the overall gap considerably.
Some pension’s analysts and accountants see the changes to RPI as a simple mechanism to reverse the boost given to the formula effect in 2010, and to rein in its exaggerated influence on the figures. However, any change would inevitably ensure that RPI rose more slowly than would otherwise have been the case and make it similar to the CPI.
Unfortunately this would directly depress future increases in private sector pensions. It would also cut the returns on the £18 billion worth of inflation-linked policies which have been sold by National Savings and Investment (NS&I), and also the return on index-linked bonds sold by the government to professional investors. If there was any potential detriment to gilt holders, whose index-linked holdings are currently worth £349bn, a change would have to be approved by the Bank of England and even the Chancellor of the Exchequer. Some gilt holders would also be able to demand that their holdings be redeemed immediately if the RPI formula was altered.
Daren Philip, a spokesperson for the National Association of Pension Funds (NAPF) believes that the consequences could be huge and affect private pension and investment income in the years to come. Speaking to the BBC, Mr Philip claimed:
“Pension funds are major investors in government debt, and changes to index-linked bonds could have far-reaching impacts on those investments. It could also alter the amount by which pensions being paid to former workers are increased each year.”