Bond Investors in Limbo as U.K. Debates Best Way to Gauge Prices

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Investors in the U.K.’s 278 billion-pound ($434 billion) market for inflation-linked government bonds are being held in limbo by the nation’s statisticians as they debate the best way to measure prices.

The independent Statistics Authority is asking markets and the public for views on whether the government should stop publishing the breakdown of the retail-price index, to which payments on the bonds are linked. If the data are no longer available, the securities may be shunned by investors, said Alan Clarke, a London-based economist at Scotiabank and former Bank of England official.

“Forecasting the RPI properly requires a proper breakdown of all the components,” Clarke said. “In the absence of these, forecasts are likely to be less accurate and there’ll be more unpleasant surprises when the inflation data are released. That will lead to a more volatile inflation-linked gilt market, which could deter some investors.”

Fixed-income markets are already being buffeted by Greece’s ongoing debt crisis and debates on when central banks around the world will start to withdraw record monetary stimulus. Bank of America Merrill Lynch’s U.K. Inflation-Linked Gilt Index swung between gains of 5.4 percent and losses of 4.9 percent this year, bigger than the seven percentage-point range in the same period of 2014.

‘Less Confidence’

The index was down 1.7 percent this year through Tuesday, compared with a 2.5 percent loss for conventional gilts. The U.K. sold 1.5 billion pounds of index-linked debt due in 2026 on Wednesday. Investors bid for 1.6 times the securities sold, compared with 2.99 at a sale of 2024 debt in June.

“I can foresee the potential for participants in the index-linked gilt market to oppose scrapping the publication of the sub-indices,” said Sam Hill, senior U.K. economist at RBC Capital Markets in London. “If there’s not so much information freely available about how the cash flows are likely to evolve, because the forecasts aren’t as detailed, investment decisions are made with less confidence.”

The Statistics Authority started the consultation in June and will publish a summary of responses after it closes on Sept.

15. The organization, which is independent of the government and reports to parliament, told Bloomberg News that no decisions have yet been taken and that the final report is due in early

2016.

‘Flawed’ Index

The survey follows an earlier review the authority commissioned to examine long-running concerns about the U.K.’s inflation data and whether there are too many different measures.

While acknowledging the importance of RPI in the index-linked gilt market, that review concluded in January that the way the measure is calculated is “flawed” and that the government shouldn’t use it when selling new bonds. A major difference between RPI and Britain’s other main price-growth measure -- the consumer-price index -- is that the retail gauge includes housing costs and therefore tends to be higher.

Stripped Out

It was that earlier study that raised the question of whether to stop publishing sub-indexes to RPI, such as the individual components or figures that strip out certain items. It argued that maintaining RPI in its current form could increase the gap with other inflation measures and may even risk their integrity.

The difference between RPI and CPI was highlighted on Tuesday, when data showed consumer-price inflation fell back to zero in June, while retail-price growth stayed at 1 percent.

“Forecasting the RPI without the sub-components would be like trying to ride a bike from London to Paris with a map of Europe where France is missing,” Scotiabank’s Clarke said. “You have a rough idea of where you’re going, but not exactly the information that you need.”

Long Lifetime

The U.K.’s Debt Management Office responded to the January review by saying that payments on existing index-linked gilts will continue to be tied to RPI. Some of the bonds currently in issue mature as late as 2068.

While the government has shifted to CPI to calculate certain payments -- such as pensions of its former employees, several tax rates, state benefits and social-housing rents -- RPI is still in use. Interest payments on student-loan payments are indexed to the retail measure, for example, and it’s used as the basis for many private-sector wage settlements and pensions.

“From the investing community’s point of view, there’s a realization that RPI is still here for the foreseeable future,” said Robin Marshall, director of fixed income at Smith & Williamson Investment Management LLP in London, which owns index-linked gilts. “The more information you have, the better. RPI shouldn’t become a second-class index and be regarded as such by the ONS.”

(An earlier version of this story was corrected to remove erroneous reference to debt office publishing inflation data in third paragraph from end.)

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