According to a new analysis, the Bank of England’s decision of selling back bonds to investors to reduce its balance sheet quickly could cost the government as much as £96 billion over the next few years.
The New Economics Foundation (NEF), a think tank, has calculated the cost of the Bank’s decision to implement “quantitative tightening” (QT), a process in which the central bank sells its gilts back to the financial markets. Existing bonds are allowed to mature without being reinvested.
The Bank’s monetary committee will determine the pace of the QT programme for the next year this week. Many economists expect a jump in the amount from £100 billion up to £120 billion. The Treasury would have to make more short-term transfers to the Bank in order to cover losses on the bond portfolio.
The Bank of England will announce on Thursday its monetary policy committee the pace of the sale of its gilts.
The think tank estimated that a £120 billion QT program in 2024-25, if left unchanged, would result in an annual loss of £28billion, and would amount to £96billion if it remained the same for the following three years.
The Bank’s Thursday decision could have a major impact on Rachel Reeves’ ability to meet her debt limit in the upcoming budget and the coming years.
Dominic Caddick said that the Bank of England decisions have such large fiscal implications, at a time when the chancellor is trying to maintain fiscal discipline.
There is increasing speculation that Labour may choose to use an alternative measure to the underlying debt in order to exclude the impact made by losses incurred by the Bank. This could give Reeves an extra £20 billion this autumn.
Caddick stated: “The chancellor must reconcile that her fiscal policies are imposing arbitrary restrictions on her spending decisions. Monetary policy decisions could put additional pressure on these decisions.” Both reducing the fiscal costs and reforming fiscal rules are necessary.
Caddick stated that if the Bank chose to reduce its QT program to £80 billion in this year, the Government could save around £4.4 billion or enough money to remove the controversial two child benefit limit.
The NEF calculated that if the QT was halved this year, to £50 billion, it would save the Treasury £10 billion. If the QT were to be stopped altogether, the Treasury would receive £13.5 billion.
Bank of England has stated that it will drastically reduce its current balance sheet size, which is £750 billion to minimize its exposure to interest rate risk. The Bank estimates that its bond programme will result in a net loss over the next ten years of £95 billion.
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