A top investment bank warned that the Bank of England’s decision to sell off government bonds costs taxpayers £15bn a yearly and limits Jeremy Hunt’s ability to reduce taxes.
Deutsche Bank stated that Threadneedle’s decision to reduce its balance sheet size by actively selling gilts purchased during the pandemic rather than letting the maturities mature meant that taxpayers would suffer much greater losses in the near term.
According to the current interest rate path, the taxpayers will suffer an extra loss of £15bn per year compared to the scenario where bonds had just matured. Treasury must make up any losses incurred by the Bank from its bond-buying program, also known as quantitative ease (QE).
The rapid rise in interest rates has pushed the program into the red. The Bank has decided to sell bonds when the prices could be at their lowest.
The Bank of England announced this autumn plans to shrink its balance by another £100bn in the coming year, which includes £50bn of sales of gilts. This is part of a program known as quantitative tightening.
The Treasury has transferred £29.1bn (£29.1bn) to the Bank in order to cover the losses caused by QT during the last year.
Sanjay Raja is the chief economist at Deutsche Bank. He said that the additional costs of active QT will add to the debt burden for the Chancellor, reducing the space available for tax or spending cuts in the short-term, especially given his limited headroom in meeting the debt rule.
Mr Raja pointed out that active sales, where the Bank sold bonds instead of letting them mature, were causing greater losses for the Treasury.
Deutsche Bank reported that £11.7bn (or £7.5bn) of the losses in the last year were due to active gilt sales. This includes £7.5bn from long-dated debt where prices have dropped sharply.
He said: “The costs of QT are not negligible.” The Bank has suffered more losses due to higher interest rates. If QT is continued indefinitely, the overall losses are likely to exceed the gains that have been transferred to Treasury over the past decade or two.”
According to internal estimates, the taxpayer could be required to pay up £170bn in QE costs over the next decade.
Sir John Redwood who was Margaret Thatcher’s former head of policy urged the Bank not to actively sell bonds.
He said: “They are making a double error by giving us inflation through too much quantitative ease (QE). They’re now giving us too much austerity with too much QT. Interest rates are too high, and they suffer heavier losses.
The Treasury is not in the mood to cut taxes because it has sent so much money into the Bank of England.
The Bank of England pays commercial lenders a rate of 5.25pc on the reserves it holds at the central banks. This is a far greater return than the gilts that the Bank has in its vault.
In the reverse, when interest rates reached record lows between 2009 and 2020, a maximum of £123.8bn was transferred to Treasury.
Some economists suggest that the Bank scrap interest on commercial lender deposits, a move which could save the taxpayers billions.
Lord Macpherson – a former permanent Secretary to the Treasury – said that this could be viewed as a tax against banks.
He said: “If government interfered with monetary policies, it would undermine the Bank’s independence, which would raise doubts in the market as to whether the Bank can be trusted. You might have to pay more for debt.”
“My guess is that there will be increased political pressure to act, either by putting pressure on Bank of England which I believe would be undesirable or possibly taxing the banks more who have benefited from this policy.”
The Bank is the one that makes the decisions on the size and composition for any bond sales.