Index-linked UK bonds face worst year in a decade

What's Down: UK inflation-protected bonds are poised for their worst year in more than a decade as government proposals to change the way it calculates a gauge of retail prices threaten to lower payments on the debt.

British inflation-protected bonds are poised for their worst year in more than a decade as government proposals to change the way it calculates a gauge of retail prices threaten to lower payments on the debt.

The £290 billion market in the securities linked to the retail-price index handed investors a loss of 1.2 per cent as of Wednesday, a reversal from its spot as the top performer in developed markets last year, when the bonds returned 21.4 per cent.

A recalculation of inflation indices may save the government about £7bn a year by 2016-2017 at the expense of investors, said an estimate by the London-based research firm Capital Economics.

Jil Matheson, the national statistician, is due to announce on January 10 her recommendation for adjusting the retail-price index to address anomalies in clothing-price calculations.

Baring Asset Management said it was holding back on buying index-linked gilts, while Pacific Investment Management said it was refraining from investing in so-called linkers with later maturities as the proposal risks undermining Britain's credibility as a debt issuer.

"I am unenthusiastic on long-dated UK index-linked bonds," said Michael Amey, a London-based money manager at Pimco, which runs the world's biggest bond fund.

"They will continue to suffer due to uncertainty over the calculation.

"The debate over changes to the inflation measures gives a sense of original contracts being revised, and the investment goalposts being moved."

The yield on index-linked securities maturing in November 2022 was at minus 0.78 per cent in London afternoon trading, compared with minus 0.91 per cent on December 7, the lowest level this year on a closing-price basis.

This year's performance is the worst since 2001, when the bonds fell 1.56 per cent, according to Bank of America Merrill Lynch's UK Inflation-Linked Gilt Index.

Merrill's Global Inflation-Linked Index rose 6.8 per cent, while similar bonds from other markets returned from 0.67 per cent in Sweden to 28 per cent in Italy.

The review may add to concern that the government is changing its calculations to help to improve public finances, even though the independent Consumer Prices Advisory Committee is driving the investigation.

The finance minister George Osborne's interim budget this month surprised legislators by including in economic projections income from a recent coupon transfer from the Bank of England and the planned sale of 4G mobile-phone spectrum licences.

* Bloomberg News