By David Milliken
LONDON (Reuters) - Britain's government would risk being sued by bondholders if it made major changes to the outdated inflation index used to calculate their payments, Bank of England deputy governor Ben Broadbent told lawmakers on Tuesday.
Britain's statistics office says the retail prices index (RPI), first introduced in 1947, is no longer a reliable guide to inflation and overstates the true rate of price increases measured by its consumer prices index (CPI).
RPI inflation rose by 3.5 percent in the year to August, compared with 2.7 percent for CPI.
But RPI continues to be used to set interest payments on new index-linked government bonds, student loans and in commercial contracts in the rail industry and some private pensions.
BoE Governor Mark Carney said in January that the government should phase out issuance of RPI-linked gilts over the next seven to 10 years in favour of a measure like CPI.
However, reducing the cost of the existing stock of inflation-linked government borrowing by redefining RPI to make it more similar to CPI would pose thorny legal and political problems, Broadbent told Britain's upper house of parliament.
"This is a big political task for the government if it chooses to engage with it," he said in a committee hearing into the ongoing use of RPI.
"Unless it was a very gentle process ... where you simply shifted all new contracts to another index and allowed the rest gradually to shrink, it wouldn't be without legal risk."
These considerations -- rather than any unwillingness from the Office for National Statistics to ask the government to allow it to revamp RPI -- were the main reasons for the failure to change how the index is calculated.
The government agency which issues debt, the UK Debt Management Office, rejected a move to CPI from RPI for new gilts in 2011 after consulting with gilt investors.
It has since argued that issuing new RPI-linked bonds does not represent bad value for taxpayers, as the price investors pay for the bonds reflects the premium they offer over CPI.
However, Broadbent said he did not believe that issuing CPI-linked debt would cause damaging fragmentation to the 1.58 trillion pound ($2.07 trillion) gilt market.
($1 = 0.7615 pounds)
(Reporting by David Milliken; Editing by Matthew Mpoke Bigg)