UPDATE 1-UK RPI decision allows greater linker issuance, DMO says

(Updates with comments on green bonds)

LONDON, Dec 3 (Reuters) – Britain will be able to issue more inflation-linked bonds over the next four months now that the government has decided that the Retail Prices Index measure of inflation will not be phased out before 2030, the UK Debt Management Office said on Thursday.

Last week, finance minister Rishi Sunak rejected calls from government statisticians to rapidly phase out the RPI measure used to calculate bond payments, saying it would be too disruptive to bond markets.

Government statisticians say RPI tends to overstate inflation relative to newer measures of consumer price inflation, which leads to higher costs for the government if this is not factored into the bonds’ initial sale price.

DMO chief executive Robert Stheeman said uncertainty about the future of RPI had reduced liquidity in the index-linked bond market at a time when the government was seeking to raise a record amount of funds due to COVID-19.

“It’s been a very significant issue,” Stheeman said in an interview with Britain’s Society of Professional Economists.

“We’re doing much more in this final quarter, where people know the outcome of the consultation,” Stheeman added, after describing indexed-linked issuance plans for December and the final quarter of the 2020/21 financial year.

Britain is due to issue 485.5 billion pounds ($652.9 billion) of government bonds this financial year. Index-linked gilts will make up around 12% of issuance during the remainder of the financial year, up from 6% so far.

Stheeman also highlighted more issuance of long-dated conventional gilts to lock in low borrowing costs, after slightly favouring short-dated gilts, which appeal to a wider base of investors, at the start of the pandemic.

Britain is due to issue its first green bond next year, a prospect which the DMO had been sceptical about in the past due to the risk that it would have to offer a higher interest rate to compensate for the lack of liquidity in the new type of debt.

But countries such as Germany have issued green debt – aimed at investors keen to fund environmentally friendly public infrastructure – at a similar cost to conventional bonds.

“Today, compared to where it was one or two years ago, pricing for green products has got tighter and tighter. That points to strong investor demand and also suggests that sometimes it doesn’t pay to be the first mover,” Stheeman said.

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