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75 Bps Of Rate Hikes In '11 Will Cause Rpi To Rise 0.5%

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http://www.bondvigilantes.co.uk/blog/2011/02/18/1298047740000.html

snippy snippy......

There is an interesting and frequently overlooked short term dynamic between inflation and interest rates. Mortgage interest payments (MIPs) are a part of the Retail Price Index (RPI) number. MIPs aren’t part of the Consumer Price Index (CPI), the measure of inflation the Bank of England target, although bond markets are (currently) priced off RPI, so that means MIPs matters.

MIPs represent 3.4% of the RPI basket today. So Jim emailed us from the ski slopes saying we should find out what proportion of borrowers are on SVR and trackers, make some assumptions about a plethora of things, and try to estimate what proportion of a rate hike would feed directly into higher MIPs and so into RPI.

What we ended up doing instead, somewhat indolently, was calling BarCap’s inflation guru, Alan James, and asking him what his estimate of the sensitivity of RPI to a rate hike is? Alan was (and is) a great help to us in our preparation for the inflation funds, and I should take this opportunity to thank him! Unsurprisingly, to those who have seen Alan present or who have met him, he had already done this work, and he informed us that his belief is that the relationship is about 0.66, meaning that two-thirds of a rate hike will directly pass through to RPI via MIPs.

The market is now pricing in three 25 basis point rate hikes this year. That means of 75 bps of hikes, MIPs will be pushed up enough to cause RPI to rise by about 0.5%. So the Bank of England hikes rates to lower inflation, and a direct offshoot of this is that RPI actually rises! As this MIPs increase feeds through to RPI, I'd expect to see the front end of the linker curve outperform conventional gilts. It's not unreasonable to expect breakeven expectations to fall at the longer end reflecting the belief that the dawn of a monetary policy tightening cycle will mean we’ll be moving towards a structurally lower inflation environment. Interesting, these unintended consequences…

Ooops.........

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Excellent so a rate hike will cause inflation to go even higher, that will make a great letter to the chancellor.

Inflation is above target because I've stupidly put up interes rates to curb inflation. Something is telling me our measure isn't working.

Hilarious.

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Excellent so a rate hike will cause inflation to go even higher, that will make a great letter to the chancellor.

Inflation is above target because I've stupidly put up interes rates to curb inflation. Something is telling me our measure isn't working.

Hilarious.

Just take MIPs out of RPI, problem solved. Simples.

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This is why the bank of england doesn't, and never did, target RPI.

They used to target RPIx - I.e. without interest payments.

However I do expect this to be trotted out why we shouldn't have a rate rise - most people will believe it because they are stupid.

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Theres a difference between inflation and a measure of inflation.

Exactly. This is a BS story.

RPI isn't the MPC's target - CPI is. If CPI isn't directly affected by mortgage rates going up, raising interest rates won't raise the MPC's inflation measure, and it won't cause Merv to have to write a letter.

Raising interest rates increases borrowing costs, so for borrowers their costs are 'inflated'. This is hardly an unintended consequence of a rate rise, but rather the point of a rate rise.

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This is why the bank of england doesn't, and never did, target RPI.

They used to target RPIx - I.e. without interest payments.

However I do expect this to be trotted out why we shouldn't have a rate rise - most people will believe it because they are stupid.

Somewhat sad to think how much the author of this piece gets paid (M&G have £190 billion under management) when he's clearly not all that bright.

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Somewhat sad to think how much the author of this piece gets paid (M&G have £190 billion under management) when he's clearly not all that bright.

Not as sad as it is to see the author totally misinterpreted and called "not all that bright".

The article is about breakeven inflation rates and the relative pricing of index-linked vs conventional gilts in response to a rise in mortgage rates. IL gilts are indexed by RPI, and the inclusion of MIPs in the RPI has always complicated pricing.

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So, when the MPC dropped the interest rates by percents then the only deflation they were targetting was pretty much that of their own making.

Edited by OnlyMe

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Good article, good thread. I figured this was one of the factors that tipped RPI into negative territory as interest rates were slashed. Kind of just assumed it, so it's good to hear some more concrete analysis.

Over Christmas, a visiting Aunt and Uncle explained to me how they had offloaded all their NS&I linkers during this period because 'they were paying no interest'. They proceeded to explain how they now have the benefit of cash on hand 'in case our daughter wants to buy a house'. That cash is now in Santander 'because of the great rates'.

The mind boggles.

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One thing to remember is that the ONS has now changed how mortgage interest payments (MIPs) are measured in RPI.

Up until February last year they were using the average Standard Variable Rate (SVR) as the MIP measurement, but they’ve now changed this to the Average Effective Rate (AER). The AER incorporates fixed rate mortgages, tracker rates etc. as well as mortgages tied to SVR.

The rationale was fair enough - the AER better reflects the average interest rate being paid across all UK mortgages. However the timing of this change (at the rock bottom of the interest rate cycle) was blatantly disadvantageous to index-linked gilt and NS&I certificate holders. When rates go back up, RPI inflation won’t rise as much as it would likely have done if the old SVR measure had been used.

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You're all idiots.

I've pointed this out for years.

Each time they lowered interest rates, they LOWERED RPI as a result.

Knockinging interest rates down from 5% to 0.5% knocked 3%+ off the inflation figures.

This held down RPI as real inflation got out of control.

The catch is now if they put interest rates back to 5% inflation will hit 10%.

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However I do expect this to be trotted out why we shouldn't have a rate rise - most people will believe it because they are stupid.

The problem - not that people are stupid, but that the system is meant to deceive.

I recall Warren Buffett saying he declined to invest in mortgage backed securities because the 1000 page contracts were intentionally incomprehensible.

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You're all idiots.

I've pointed this out for years.

Each time they lowered interest rates, they LOWERED RPI as a result.

Knockinging interest rates down from 5% to 0.5% knocked 3%+ off the inflation figures.

This held down RPI as real inflation got out of control.

The catch is now if they put interest rates back to 5% inflation will hit 10%.

Always been in that camp,I don`t like making predictions ,but I got a sneaky feeling that they are going to put house price`s back in to the cpi figures {my guess is in the budget} and then remove Mip from the RPI index .

This will kill to birds with one stone and allow them to increase interest rates in May[before they are forced to] without to much effect on the inflation figures ,also by then ,[with a bit of luck] house prices will be falling which will water down the CPI figures a bit

I have always thought this was one of the main reasons why the BOE are so keen to keep the 0.5 rate it`s all about fiddling the figures ,and like you say they are between a rock and a hard place ,and the above is the only way out ,as sooner or later they are going to have to raise IR`s

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  • 312 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
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      • Even
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      • up 5%



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