The Bank of England is under growing pressure to pause a bond-selling programme set to cost UK taxpayers more than £100billion, as its Monetary Policy Committee prepares to meet this week.
The nine-member committee is expected to keep interest rates on hold despite soaring energy prices caused by the US war on Iran, which is fuelling inflation. It will also decide the pace of bond sales that are crystallising huge losses for the Bank, and the taxpayer, as government borrowing costs rise around the world.
The Treasury has to cover these losses, adding to the Government's near-£3trillion debt burden. That is an extra headache for Chancellor John Healey as he tries to balance the books in next month's Budget.
How the Bank built up its bond pile
After the 2008 financial crisis and during the pandemic, the Bank bought £895billion of bonds, or Government IOUs, to help keep the economy afloat. It bought this debt from investors at very high prices when interest rates were ultra-low. Bond prices rise when interest rates fall, and fall when rates rise.
The Bank's quantitative tightening programme involves selling those bonds, now worth less, back into the market. At first the policy of so-called quantitative easing proved highly profitable for taxpayers, with £124billion transferred to the Treasury.
That changed in 2022, when interest rates rose sharply after Russia's invasion of Ukraine in an effort to curb double-digit inflation. Since then the Bank has been aggressively selling gilts into a falling market, reducing its debt pile to £489billion, but at mounting cost to the taxpayer as interest rates have stayed higher for longer than expected, and may rise further still.
Projected losses mount
The Office for Budget Responsibility, the Government's official forecaster, projects further losses under the quantitative tightening plan of £94billion over the next four years. That includes £22billion of crystallised losses on active gilt sales, where bonds are sold off before they mature.
If the Bank, which is independent of the Government, slows the pace of debt sales, currently running at £70billion a year, or halts them altogether, these losses would be lower or stop entirely. The UK is the only major central bank actively selling government debt.
Bailey defends the programme
Bank Governor Andrew Bailey admitted to MPs last week that the Bank's "more transparent" system of transferring losses to the Treasury was "quite painful." But he insists that shrinking the Bank's balance sheet by offloading its debt pile is necessary so that it can intervene again if the economy suffers future shocks.
Economists call for a rethink
Not everyone agrees with that approach. "I think the Bank should stop active QT and allow the balance sheet to shrink naturally through gilts maturing," said Gerard Lyons, chief economist at wealth manager NetWealth.
"The Bank of England is quite of the tune with the rest of the world," said William Ellis, senior economist at the Institute for Public Policy think-tank. He said the pace of bond sales was much higher than at the European Central Bank and the Federal Reserve, which is "now doing the complete opposite" and buying back US debt. "A pause makes sense," he added.
Economists expect the Bank to slow the pace of bond sales from £70billion to £50billion a year while maintaining active gilt sales.
Mike Denham, former chair of the TaxPayers' Alliance, said the policy "has been a terrible mistake." He added: "The Bank has painted itself into a corner."
Bank taxes and reserve interest
Bailey also opposes any increase in bank taxes to raise money for more spending on health, welfare and defence.
Lenders are making an extra £20billion a year from interest payments on reserves held risk-free at the Bank of England as a result of rates staying higher for longer. The amount of interest paid on those reserves could be curbed through a tiered system.
"A tiered system is a reasonable compromise," said NetWealth's Lyons. He said it "would save the taxpayer money while still addressing the Bank's concern about the transmission of monetary policy."
But Bailey is opposed to any such changes. He told MPs last week that the Bank's base rate, currently 3.75 per cent, was "the way we implement monetary policy, the anchor point in our system." He also warned that banks might seek to protect their margins by charging customers higher borrowing costs and offering lower savings rates.
