Exclusive: Ex-BOE Weale Backs CPIH As Key Inflation Measure

-Weale Sees No Intrinsic Flaws With CPIH; Could Be Used As Inflation Target

-Weale Warns Against Making Small Change To 2% Inflation Target Due To CPIH/CPI

Wedge

-Weale Says It Is Time To Jettison RPI

By David Robinson

     LONDON (MNI) - Former Bank of England official Martin Weale, who sits on

the experts' panel at the Office for National Statistics, said CPIH, which

includes housing costs, should become the key inflation measure once technical

issues are resolved. 

     The Monetary Policy Committee's current target measure, the Consumer Prices

Index (CPI), does not include housing costs and there has been a long-running

debate over which measure should replace it. Weale, who served on the MPC from

2010 until 2016, said in an interview with Market News International that he

believes the debate has been resolved in favour of using CPIH.

     The Office for National Statistics publishes a monthly commentary on CPIH

but the market and public focus is firmly on CPI, and to some extent on RPI,

which is still used by the government as the reference measure for index-linked

gilts and other items, such as student loans and rail fares. 

     "If it (CPIH) were adopted as the inflation target that would in itself

make it the focus of attention," Weale said. 

     When back in 2003 CPI replaced RPIX as the inflation target, the target was

lowered from 2.5% to its current 2.0%, as the expected long-run difference

between the two measures was reckoned to be around 0.5 percentage point. 

     As a result, monetary policy was unaffected but a switch from the 2.0% CPI

target to CPIH could be fiddly, as the wedge between the two has been small. 

     Weale said that if CPIH was growing at, say, a quarter of a percentage

point faster than CPI "you might think you wouldn't really want to change to a

target of two and a quarter (percent)." 

     "I think there is an argument for keeping the inflation target simple and

that means not having rather minute intervals that you seem to be worrying

about," he added. 

     If CPIH was running a bit above CPI and Chancellor of the Exchequer Philip

Hammond chose to set the MPC a new 2% CPIH target, then inflation could be

running a bit stronger relative to target than before the switch, implying that

at the margins monetary policy should be tighter, although the MPC has shown it

can treat the target flexibly.

     There are signs that the UK housing market is cooling and prices are

falling in some areas, but Weale noted that as CPIH uses rental values this does

not mean that CPIH would keep running below CPI. 

     "We may get housing deflation but to the extent that happens I should have

thought it was likely to be associated with an increase in yield in housing, so

you may well find that house prices go down but but rents do not necessarily

fall," he said. 

     The UK Statistics Authority's assessment team met this month to look at

CPIH's progress towards being re-accredited as a national statistic, after it

lost that status in 2014 over problems with the way rental costs were

calculated. 

     Once accreditation is granted to CPIH, things could move swiftly. 

     "I don't think it has any intrinsic problems," Weale said. "I think

conceptually it is the appropriate way of measuring the cost of housing." Weale

is one of the eleven members of the Statistics Authority's Technical Advisory

Panel for Consumer Prices. 

     One criticism of CPIH has been that the rental and owner occupied sectors

are dissimilar, with large amounts of data available on rental values for city

apartments, for example, but not for village houses. 

     "You are relying on statisticians to carry out an imputation ... More

people live in towns than in English villages. It is true the rental market is

thin in some parts of the country but I suspect that where the value of housing

is at its greatest then the market probably isn't so thin," Weale said. 

     Once CPIH is re-accredited as a national statistic, Weale sees no benefit

in reviving the old debate over whether alternative inflation measures that

include housing, such as the net acquisitions approach championed by Eurostat,

the EU statistics office, are better. 

     For "the people who are keen on net acquisitions or keen on mortgage

interest that will become another opportunity to say they are keen on mortgage

interest or net acquisitions," he said. 

     Weale believes that debate is over and it is time to move on. He said that,

unlike CPIH, the net acquisitions measure, based on price changes for houses

which are new to the household sector, is fundamentally flawed as when the

owner-occupied housing stock is declining the measure behaves perversely. 

     "What we have seen over the last 15 years or so (in the UK) is that the

stock of owner-occupied housing has been declining. Now, taken logically, that

would imply you put housing in with a negative weight in the consumer price

index and then you would have to explain to people that the price index is weak

because house prices are going up. That is not a job I would want to take on for

myself," Weale said. 

     -Time To Jettison RPI 

     The UK has ended up with a hotchpotch of price indices. The government has

continued to issue debt, and link rail fares, student loans and some benefits to

the discredited RPI measure, which was de-designated as a national statistic in

2013. Weale said that this continued use is unjustifiable.

     The improved RPI measure, RPIJ sunk without trace as nothing was ever

linked to it and CPIH, which was meant to become the headline measure, was

itself de-designated as a national statistic in 2014 over technical problems

with the way rents, which are used as a proxy for owner occupied housing costs,

were calculated.

     "Why ... the government continues to issue RPI linked debt rather than CPI

linked debt I don't know. I have never heard a good justification for it," Weale

said. 

     "You could make the argument that the CPI market would be thin (but) that

was true of RPI linked debt when it started," Weale added. 

     He said he simply did not understand why the Debt Management Office (DMO)

continued to issue inflation linked gilts based on RPI, which was 3.5% in June

compared to 2.6% for CPIH. It is simplistic to assume that changing to CPIH for

inflation linked gilts would automatically cut debt interest costs, as market

participants would demand higher real yields, but Weale highlights the

perversity of using a flawed measure and pushing up the price of rail fares and

the cost of student debt as a result. 

     "Most people when they discover something has been going wrong they try and

correct it. Of course, RPI stopped being a national statistic but that subtlety

was probably lost on most users including possibly civil servants who had been

linking student loans to RPI," he said. "I do think the government could adopt a

policy of winding up the use of the RPI," Weale added.

     The government could now wait for CPIH to become a national statistic

rather than having a brief interlude of using CPI as the reference measure for

gilts and student loans. 

     The DMO in previous consultations on CPI linked gilts has highlighted the

risk of fragmentation, and associated illiquidity, in the index-linked gilt

market so could be reheated if CPI linked gilts were rapidly replaced by CPIH

ones. 

     Meanwhile, there is the absurdity of National Statistics stating that it

will continuing to produce an unchanged RPI measure because it is required as an

inflation measure for index linked and other debt. The DMO has been issuing

longer and longer-dated index-linked gilts, with the 50-year maturity cap

removed back in 2012. 

     "This is very much what worries me and the ONS has said that there won't be

major changes in the calculation of RPI," Weale said. 

     In, say, 60 years' time, "will we still be using shops? You can see the

problem, what does not changing mean?" Weale said. 

     The ball is now in the government's court. Nick Macpherson, who between

2005 and 2016 was the top Treasury official, has said on social media that while

it was wrong to index taxes and charges to RPI, the fault was with the

government and not National Statistics. 

     If CPIH is approved as a national statistic before the Autumn Budget,

Hammond could then take that opportunity to state, at the least, his intention

to adopt it as an inflation target and to back its use for future gilt issuance

- even if he allows a lag before doing so. Weale is clear that a switch away

from RPI is long overdue and that there is a strong case for the eventual

adoption of CPIH.

--MNI Paris Bureau; tel: +33 1-42-71-55-41; email: jack.duffy@marketnews.com

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

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