Gilt Investors May Face a Premium for CPI Inflation Hedge, Barclays Says
U.K. investors may be charged a premium to hedge exposure to the consumer price index, or CPI, ahead of possible changes to the measure of inflation used for some pensions, Barclays Plc said.
“They will have to pay up for it” if they want to buy the protection before any decision is made on the sale of government bonds linked to CPI, said Alan James, a fixed-income analyst at Barclays in London, in an e-mailed response to questions today.
All U.K. inflation-linked debt, used by pension funds to manage their liabilities, is currently based on the retail price index, or RPI. The government is planning to align benefits and public services pensions to CPI, which has been lower than RPI on average during the past 20 years. Robert Stheeman, the head of Britain’s Debt Management Office, said this week he’s waiting for legislative clarity before studying any change and wants to avoid “unnecessary fragmentation” in the gilt market.
“An active market has yet to develop in CPI inflation,” James said in a research report dated yesterday. “We would not expect banks to be willing to take on basis risk at anything but a conservative level prior to details of government supply emerging,” he said.
While he estimates CPI inflation is likely to stay more than 100 basis points lower than RPI “in the medium term,” James doesn’t expect a swap contract between the two measures to trade cheaper than 50 basis points for a contract length of 10 years or longer before the government announces its plans for inflation-linked securities, he wrote in the note.