BoE to Lose £billions a Month on QE Stockpiles – Taxpayer on Hook
By TruePublica: This story has been completely neglected by the mainstream media, both published and broadcast. However, the financial papers have been busy warning of the consequences of the 2008 financial crisis and quantitative easing or QE that never really went away. Its toxic legacy will haunt the UK for another generation – and it will do so at the worst of times.
And it’s not as if the government have not been warned. On the 16th of July last year, the House of Lords published a paper – “Quantitative Easing – A Dangerous Addiction”. In just one paragraph of many warnings in its final conclusion, it read:
“When quantitative easing was introduced it was envisaged that it would support the UK economy after a sharp fall in aggregate demand following the 2008–09 global financial crisis. However, over the last decade it has been deployed in various circumstances quite different from those of 2009 to tackle a range of different problems. This has had a ratchet effect, whereby the scale of quantitative easing has been increased repeatedly, with no subsequent attempts to reverse it. This has only served to exacerbate the challenges involved in unwinding the policy. The Bank insists that quantitative easing has been an essential response to extraordinary and fast-moving events and always in line with its price stability mandate. However, the effects of quantitative easing remain poorly understood and in recent years, particularly during the COVID-19 pandemic, the Bank has struggled to explain why it was the appropriate response to particular economic circumstances.”
The consequence of a Tory party in power since 2010 and the Bank of England being addicted to quantitative easing is a looming disaster. Many might say the BoE is fully independent of government. This is not true. And this story will hit the mainstream media at some point in the future because tax revenues – the money required to run the country, will fall because a looming recession is coming – just at the moment that the taxpayer will be paying losses, guaranteed by the treasury to cover the BoE – that covered the backs of out-of-control banks.
The Bank of England’s quantitative easing program is on course to book a £3 billion loss in the coming weeks as the central bank’s massive bond holdings start their journey from government cash cow to a drain on the public finances.
The BOE decision this month to begin unwinding its £895 billion bond stockpile (from the financial crisis, Brexit impacts and Covid-19 to name a few) kicked off a process that will see gilt holdings fall by more than £200 billion by the end of 2025.
The issue is that the price paid on most of those securities was well above face value (to save the banks back in 2008/09 and beyond), leaving the central bank in the red once they mature or are sold. Under a government indemnity with the BOE, the state must make good the difference. The shortfall for the total QE holdings amounts to about £115 billion (or £111 per household to the taxpayer).
The QE reversal is a huge moment for a tool that’s gone from emergency measure to core policy (addiction to cover other problems that really required government intervention) over the past decade. It’s part of an aggressive monetary tightening by the BOE, which has already raised interest rates twice and is expected to follow with more through 2022.
So-called quantitative tightening starts in March when £28 billion of its gilt holdings will mature, and for the first time since QE was launched in 2009, bonds will run off the balance sheet. That will crystallize a £3 billion loss, the difference between the nominal value of the debt and the price at which the BOE bought it.
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While that shortfall will be more than covered for now by the income generated on the remaining bond holdings, the combined impact of capital losses and the higher cost of QE as interest rates rise will prove a toxic combination for Chancellor of the Exchequer Rishi Sunak.
If rates evolve as markets expect, the windfall from QE for the chancellor, which had been forecast to be 11.3 billion pounds in the coming fiscal year, will soon be whittled down to nothing. In 2025 at the latest, the Treasury will start making direct cash transfers to the BOE, according to calculations by Bloomberg.
When that happens, it will bring to an end a period during which successive chancellors enjoyed profits from QE, albeit with a warning that the bill would eventually come due. The higher rates go, the greater the damage to the government.
Jagjit Chadha, director of the National Institute of Economic and Social Research, said this week that the “handling of QE is an enormous problem.”
“At the moment, QE has yielded a return to the Treasury of over 100 billion pounds,” he told lawmakers on the Treasury Committee lawmakers on Monday. “As interest rates start to pick up to 1% and above, that flow will reverse.”
Chadha warned that transfers of taxpayer funds to the bank could pose a fresh risk to BOE independence, a matter which has come under increased scrutiny during the pandemic.
The BOE and the U.K. Treasury addressed the issue in correspondence last week, with BOE Governor Andrew Bailey highlighting an agreement that “reverse payments from the government were likely to be needed in the future” and “be met by the government on a timely basis.”
In response, Sunak pledged that “any potential future cash shortfalls will be met in full.” The two institutions declined to comment further.
In the 13 years QE has been running, the Treasury has received £120 billion as the interest paid on the gilts is round-tripped through the BOE back to the government, minus some charges. That effectively represents a saving on payments that would otherwise have been made to the private sector.
Massive Losses Expected
As the gilts mature, though, capital losses on the portfolio will have to be met. Active gilt sales, which the BOE will consider once rates hit 1%, would likely worsen the impact.
The QE program has already booked losses of about £28 billion on bonds that have matured since 2013, but they went largely unnoticed as the funds were reinvested and the cost was swallowed up by the proceeds from coupon payments.
Those payments will also more than cover the March shortfall. As a result, the Treasury will only forfeit income then rather than make a direct cash payment.
In 2025, however, if interest rates follow expectations, the Treasury will have to declare an annual transfer to the central bank in the budget, a payment that will likely become increasingly common as the plan is unwound. If rates rise quicker or to a higher level, that payment could come even earlier.
Chada then said – “Then we’re in a world in which we’re not quite sure why interest rates may not be going up. Is it because of inflation prospects or is it because we’re worried about reversing that flow of income?”
At no time has any Chancellor – either Sunak, Javid, Hammond or Osborne admitted that there has been a QE windfall – only that they have steered the economy with good economic policy. The tide is turning on QE and the risks of that gamble are becoming more clear. It was always known that if interest rates rise, the cost of maintaining the national debt would rise. At no time was the general public warned that the QE programme, one invented to save the banks, that then inflated asset prices such as stocks and property for over a decade – would be subject to that 200-year-old English phrase – “what goes up, must come down”.
This is not a government that is fiscally prudent. It pretends it is – but clearly never really understood the consequences of its decisions. The Bank of England is like any other bank – its losses will be covered by the taxpayer. The taxpayer will be hit with these losses at a time when it will be least able to do so. Austerity will return but the government won’t call it that.
There’s a lot more trouble ahead than we’re being told.
You can read my description of QE and a prediction in 2018 of what was going to happen in the near future HERE