RIP RPI: Price index changes to gilts could cause 30% loss for holders

Scrapping RPI as the preferred method for calculating returns from Index Linked Gilts could cause a huge spike in volatility in the sector and wipe a third off the value of parts of the market, Sandra Holdsworth, Head of Rates at Kames Capital, has said.

The UK Government is to undertake a consultation into the calculation and use of the RPI (Retail Price Index) with particular reference to Index Linked Gilts, the effect on public finances and the integrity of the statistical system.

The previous Chancellor announced that the process of looking at fundamental changes to RPI will be officially launched after the March 2020 Budget. The end result could see it scrapped as a statistic used by index-linked government bonds and switched for CPIH (Consumer Prices Index including owner occupiers’ housing costs, now the Bank of England’s preferred measure of inflation).

This will have a potentially major effect on the market, and could cause a huge sell-off in the multi-billion pound linker market, Holdsworth warned.

“The RPI has consistently risen at a faster pace than the recommended index, CPIH, so to align the indices will reduce the value of future cash flows and the price of the bonds will fall,” she warned.

“The longest dated bonds will suffer the biggest price falls. It is estimated that the market price of the longest bond in the market, maturing in 2068, could fall as much as 30% should the consultation rule the change should occur.”

However the process is beset by uncertainty. The consultation was due to start in January 2020 and report by the end of the current financial year but this timeline has slipped to March already, with results now expected by the end of April.

The timescale for any change, should it occur, is also unknown, although the previous Chancellor already ruled out any switch before 2025.

Holdsworth added various aspects of the proposal are lacking detail: “There is the question of compensation, whether investors would be compensated and if so by how much? Would it apply to those with derivatives linked to the RPI too? What would happen to those who receive payments linked to RPI? Would they be included?

“It is because of these uncertainties over both timeline and detail that all remains calm in the UK index linked market for now – but don’t expect it to last.”