Inflation Swaps Explained: Who Pays, Who Receives and Why

An inflation swap exchanges a fixed rate for payments that rise with an inflation index: in the UK usually RPI, in the euro area HICPx. One side pays inflation and the other receives it. Pension schemes and insurers receive it. Water companies, energy networks and some renewable generators pay it.

Receivers want it because what they pay out rises with prices. Payers already have revenue or an asset base that rises with inflation, so for them the swap is not a bet on prices. It makes a debt or revenue line move with the thing it is meant to match.

They do it in two ways. Bond style turns fixed-rate debt into debt that grows with inflation. Revenue style swaps an inflation-linked income stream for a fixed annual increase. Either can be zero coupon, with one payment at maturity, or pay-as-you-go, with payments along the way.

In the UK the index is usually RPI, the Retail Prices Index, but an RPI swap can be overlaid with an RPI/CPI "wedge" swap to turn it into CPI. Some water companies do this. Their revenues and asset base rise with CPIH, which is CPI plus owner-occupiers' housing costs. CPIH has no real swap market, so CPI is the closest hedge, and they keep some CPIH vs CPI basis risk.

Who pays and who receives

Pension schemes hedge with swaps as well as index-linked gilts, the UK government bonds that pay RPI.

Ofwat puts 45.4% of water company debt at March 2025 as inflation-linked once swaps are counted. Some of those swaps run to 2063.

Why a higher breakeven means a cheaper real coupon

A breakeven is the inflation rate the market prices in. Strip it out of a nominal yield and what is left is the real yield, the return above inflation. For the same nominal cost of debt, a higher breakeven means a lower real coupon: against a 5.0% nominal yield, a 3.0% breakeven leaves about 1.94%, and a 3.5% breakeven about 1.45%.

That real coupon is paid on a notional that grows with inflation, unlike a nominal coupon on a fixed amount, so the cash paid rises each year and the growth itself is paid at maturity.

UK breakevens are high. Swaps reference RPI, which the DMO assumes will run about 0.9 of a point above CPI until 2030, so the Bank of England's 2% CPI target implies roughly 3% RPI. Since the start of 2025 the 20-year RPI breakeven implied by gilts has stayed above that, between about 3.1% and 3.5%. Today's levels are on our UK inflation swap rates page.

That is the attraction for a sterling issuer: a high breakeven buys a low real coupon. It is not a sure saving, because the issuer then pays the inflation that actually turns up and comes out ahead only if that ends up below the breakeven. If inflation overshoots, its revenue or asset base rises with it.

In euros, breakevens sit near target

Euro swaps reference HICPx, euro-area inflation excluding tobacco. French law bans indexing most contracts to general prices, with exceptions such as transport concessions: French motorway tolls must rise by at least 70% of inflation.

The main difference is price. Since the start of 2025, ten-year euro breakevens have sat between about 1.9% and 2.3%, close to the ECB's 2% target. Sterling breakevens sit above the level their target implies, so a sterling payer gets more of a cut in the real coupon.

Bond style: debt that grows with the asset base

UK water and energy regulators set a regulated asset base (RAB): the value of the network a company earns a return on. It rises each year with inflation, once RPI and now CPIH. Since April 2026 Ofgem has indexed only part of transmission and gas networks' asset bases.

Debt that grows at the same rate keeps gearing, debt as a share of the RAB, steady. Take a RAB of 100 at 60% gearing and no new borrowing for ten years. With index-linked debt, gearing ends at 60% whether inflation runs at 1% or 6%. With nominal debt, it ends at about 54% at 1% and about 34% at 6%.

The benefit is stability, not lower gearing. Headroom against the gearing limits in loan terms stops depending on inflation, apart from the gap between an RPI swap and a CPIH asset base, which largely closes from February 2030. Our UK CPI curve builds that change into its RPI-CPI wedge.

Rather than issue an index-linked bond, a utility can issue a conventional one and swap it. It receives the bond's fixed coupon from the bank and pays a lower real coupon on a notional that grows with inflation, plus that growth, the accretion, at maturity.

The real coupon rises with the notional. At 3% RPI the accretion is about a third of the notional after ten years, and slightly more than all of it after 25.

Illustrative, not a market quote. A 1.94% real coupon on a notional growing with RPI starts at 2.0 against 5.0. Principal of 100 is repaid in both cases and not shown.

The coupon saving is real, and so is the bill at the end.

What drives the price of a bond-style swap

The accretion does. On an ordinary interest rate swap, the bank's exposure to the issuer rises and then runs off as payments are made. On a bond-style swap the largest payment, the accretion, comes last, so the exposure keeps building: at 3% RPI it reaches about 109% of notional by year 25. Water companies generally post no collateral against it; the banks rely on a super-senior ranking instead. So the bank builds the cost of that credit into the real coupon it quotes, and only an independent mid-market price shows how big that charge is: check your real coupon against mid.

The issuer has two levers to bring that charge down. A mandatory break ends the swap years early and settles it at its mark-to-market, accrued accretion included. The quote improves, but the break has to be dealt with, and breaks are often extended or settled early before they arrive. Paying the accretion down on set dates also cuts the charge: every five years at 3% RPI keeps it under 30% of notional, at the cost of paying part of the inflation bill early. At least one UK water company goes further: it has stripped the accretion out of its bank swaps and pays it to a vehicle owned by pension funds and insurers, so the bank no longer carries that credit-intensive payment.

Revenue style: locking in escalation

Much UK infrastructure revenue is indexed: Contracts for Difference (CfD) strike prices rise with CPI each year, and PFI payments are usually indexed, in whole or in part, to RPI or CPI. Project debt, though, is sized on a base case that assumes an inflation rate. If inflation runs below it, revenue falls short while fixed debt service does not.

A revenue-style swap fixes the escalation, the yearly increase in revenue. The project pays the bank the inflation uplift on its revenue and receives a fixed annual increase, set so both sides are worth the same today and sized to expected output.

Illustrative, not a market quote. Unhedged, indexed revenue ends anywhere in the shaded range. Swapped, it follows the fixed escalation.

It can also lift returns. If the fixed rate sits above the model's inflation assumption, the project locks in more escalation than planned, and with debt service fixed the modelled equity IRR improves on signing.

The gain lives in the model. The project gives up any inflation above the fixed rate, and that rate includes the bank's credit and funding charges, which, as with any renewables hedge, depend partly on where the bank ranks among the project's creditors.

The hedge does not predict inflation. It decides which inflation the model has to believe.

Bond style and revenue style side by side

Pricing it before the bank does

Breaks, pay-downs, ranking and the index set much of what an inflation swap costs, so they are worth settling before anyone quotes. Then check the quote: take away an independent mid-market price, and what is left is the bank's charge.

Weighing up a new bond or refreshing a project model? Price your inflation swap before the first bank call, or check a bank quote with our team.

Frequently asked questions

What is a bond-style inflation swap?

A swap that turns a fixed-rate bond into debt that behaves like an index-linked bond. The issuer receives the fixed coupon and pays a lower real coupon on a notional that grows with inflation, plus the accretion at maturity.

What is a revenue-style inflation swap?

A swap that fixes the yearly increase in an inflation-linked revenue stream. The project pays the bank the inflation uplift on its revenue and receives a fixed annual increase instead, the escalation rate, set so both sides are worth the same today.

Who pays inflation in an inflation swap?

The side whose revenue or asset base already rises with inflation: water companies, energy networks and some renewable generators. Pension schemes and insurers, whose payouts rise with prices, receive it. Banks stand in the middle and trade with both sides.

What is accretion in an inflation swap?

The growth in a bond-style swap's notional as the index rises, paid in one amount at maturity. At 3% RPI it is about a third of the notional after ten years, which is why it drives the bank's credit charge.

Is the swap linked to RPI or CPI?

Usually RPI, because that is where UK trading sits, though asset bases now move with CPIH and much contracted revenue with CPI. RPI moves to CPIH methods in February 2030, largely closing the asset-base gap and narrowing the one on CPI-linked revenue.