The average yield on index-linked gilts of more than 15 years maturity has risen from -0.2% in January to 0.3% yesterday, with more than half of the increase occurring this month, probably reflecting expectations that the Consumer Prices Advisory Committee (CPAC), following its recent meeting, will recommend changes to the method of calculation of the retail prices index to reduce or eliminate the “formula effect” inflation gap with the CPI and that such a recommendation will – if necessary – be sanctioned by a Chancellor keen to minimise future debt interest expenditure. (US TIPS yields, by contrast, have fallen slightly in September.)
The rise in the yield compensates future investors for a smaller prospective inflation element of the return from holding index-linked gilts. If the RPI calculation were “harmonised” with that of the CPI – one of the options being considered by CPAC – the current annual RPI inflation rate would fall by 0.9 percentage points. The recent yield rise looks modest relative to this possibility, which could also warrant a larger “risk premium” by setting a precedent and opening the door to additional formula “refinements” that could further lower recorded inflation.
Rises in index-linked yields, historically, have often preceded equity market set-backs. The current increase may differ because it does not represent a rise in the prospective real return with which stocks must compete. The mooted RPI change, nevertheless, is judged here to be negative for the UK investment climate, since it increases uncertainty and represents another example of officials intervening to affect financial outcomes in an unpredictable fashion – cynical investors will view the defensible technical arguments as a smokescreen for more “financial repression”.