CORRECTED-UPDATE 1-UK statisticians unexpectedly reject inflation change

(Corrects lead to show stats body rejected change)

By David Milliken and Olesya Dmitracova

LONDON, Jan 10 (Reuters) - Britain's top statistician unexpectedly decided against major changes to the country's longest-running inflation index on Thursday, rejecting a move that could have significantly cut government borrowing costs.

Jil Matheson, the government's top statistical adviser, concluded that the existing Retail Price Index did not meet current international standards. But she said it would be better to create a new index rather than fundamentally change RPI, which is written into many existing contracts.

The news is a major boost to the many Britons with company pensions legally linked to RPI, and to holders of Britain's inflation-linked government debt, as some of the proposed changes would have led to much lower future increases in payments.

Sam Hill, a fixed income strategist at Royal Bank of Canada, said he was highly surprised by the move, which came after months of consultation by the UK Statistics Authority.

"I think it's remarkable that they have said that the current formula does not meet international standards, and then continue to use it for a number of key functions," he said.

Some economists had estimated Britain's finance ministry would have saved up to 3 billion pounds a year in interest payments if the change to RPI had gone ahead, out of annual debt servicing costs of 47 billion.

This would have been a boon for cash-strapped finance minister George Osborne, but after the decision by the UK Statistics Authority, his ministry confirmed that it would use RPI for future index-linked gilts as well as existing ones.

"For gilt investors, future cash flows on existing index-linked gilts will continue to be calculated by reference to RPI," Economic Secretary Sajid Javid said in a statement.

RPI, which was developed after World War Two, runs significantly higher than the consumer price index (CPI) which is used by the Bank of England to set monetary policy.

RPI also uses different statistical techniques which Bank of England Governor Mervyn King described as "outdated" in November, and in recent years the discrepancy with CPI has grown.

Before the decision, analysts at Deutsche Bank estimated there would be an average 1.3 percentage point gap between RPI and CPI inflation measures if no change was made to the RPI index.

Instead, the expected newer techniques will be applied to an index dubbed RPIJ which will appear from March onwards alongside RPI and CPI.

"There is significant value to users in maintaining the continuity of the existing RPI's long time series without major change, so that it may continue to be used for long-term indexation and for index-linked gilts and bonds," Matheson said.

Some minor changes will be made to the private rental data used in RPI, subject to consultation with the Bank of England, but the Office for National Statistics said these would not affect the average rate of RPI.

Annual RPI inflation was 3.0 percent in November, compared to 2.7 percent for CPI, reflecting a recent narrowing in the gap between the two measures due to differences in how changes in insurance and mortgage interest payments are accounted for. (Editing by Stephen Nisbet)