Par RPI Curve

The implied RPI (Retail Price Index) annual growth is computed as the difference between the interpolated yield curve for conventional (nominal) bonds and the real yield curve derived from inflation-linked bonds of corresponding maturities. This spread reflects the market's inflation expectations, as it represents the breakeven RPI rate that equates the returns of nominal and inflation-linked bonds.

Theoretical Limitations

• Projection Over Maturity: This approach projects the implied RPI rate based on coupon-bearing bonds directly onto their maturity dates, rather than decomposing the RPI expectations over different time horizons. As a result, the derived curve reflects breakeven RPI rates at bond maturities rather than instantaneous forward RPI rates.
• Non-Zero-Coupon Basis: Since the method does not rely on bootstrapping from zero-coupon yields, it inherently includes the effects of coupon payments, which can distort the representation of RPI expectations over shorter intervals.
• Nature of the Curve: The RPI curve derived from this approach is commonly referred to as a par RPI curve. It does not provide instantaneous forward RPI rates but rather average RPI expectations implied by coupon bonds up to their respective maturities.
• Potential Biases: As Gilts with lower coupons are more tax efficient they tend to trade at lower yield compared to bond with higher coupon leading to potential bias on the implied RPI rates.