BoE losses on QE greater than other central banks, says ex-rate setter

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The Bank of England is likely to incur much bigger losses on its quantitative easing programme than other central banks, according to an analysis by a former member of its interest rate-setting committee.

Michael Saunders, who left the Monetary Policy Committee last year, said the losses were likely to be larger because the central bank had bought longer-dated bonds than overseas counterparts that launched QE schemes on a similar scale after the 2008-09 financial crisis.

The BoE’s approach left it more exposed when the MPC began sharply lifting rates in a bid to tame inflation in 2021, he noted in a paper this week.

The latest official estimate that the bond-buying programme will cost £126bn over its lifetime is much larger than expected initially.

Saunders called for a rethink of the scheme, where the Treasury absorbs losses, arguing that because these are counted in the public debt ratio, the current set-up could compromise the BoE’s independence and force chancellor Jeremy Hunt into a sudden fiscal retrenchment.

The cost represents the continuing cash flow losses on the £895bn of bonds the BoE amassed from 2009 to 2022 in order to boost the economy, as well as the gains or losses made when bonds mature or it sells the assets.

The bulk of the BoE’s asset purchases were fixed-rate gilts with an average maturity of between 15 and 20 years, which were exchanged for variable rate reserves issued by the central bank.

Initially, when interest rates were at record lows, the scheme generated profits. But with its benchmark rate at a 15-year high of 5.25 per cent, the BoE is now paying a much higher rate on reserves than it receives for its gilt holdings, and its losses are mounting.  

Saunders, who is now senior economic adviser at the consultancy Oxford Economics, said both the eventual cost of the scheme, and its knock-on effects for fiscal policy, “appear likely to be much larger than in other countries”.

This was true even after allowing for different accounting policies, he said, because the longer maturity of the BoE’s bond holdings meant it would sustain bigger losses on bond sales, or a longer period of negative net interest payments, for a given rise in interest rates.

In February the BoE had an unrealised, mark-to-market loss of 23 per cent on its £830bn of bond holdings, Saunders noted. The equivalent figure for the US Federal Reserve’s losses on domestic bond holdings was 13 per cent in June, while for the European Central Bank and the eurozone’s six largest central banks it was 13 per cent at the end of 2022.

The BoE is indemnified against these losses under an agreement signed with the Treasury in 2009, intended to ensure that monetary policy is not constrained by risks to the central bank’s balance sheet. Any profits or losses on the scheme are transferred to or from the Treasury each quarter.

Richard Hughes, head of the UK’s Office for Budget Responsibility, the fiscal watchdog, said in recent evidence to parliament that this system had the advantage of transparency.

“In other countries, these losses accumulate in the balance sheet of the central bank, which at some point may need to be recapitalised by the taxpayer,” he told the House of Commons public accounts committee. “Central banks are always indemnified by taxpayers, whether you write it down or not.”

But Hughes also acknowledged that losses on the scheme would directly affect the government’s ability to put public debt on a downward path — the main fiscal rules set by Hunt.

Saunders said it was “undesirable” to count the BoE’s losses in the public debt measure used for the fiscal rules.

In the short term, this created “powerful incentives” for the Treasury to influence MPC decisions on the pace at which the BoE reduced its bond holdings, he said, “potentially eroding the MPC’s independence”.

In the long term, it could make the Treasury “reluctant to sanction future asset purchases, even if these are justified under the MPC’s remit”.

The Treasury, which has previously stressed that decisions on QE are made to meet the MPC’s objectives, said cash flows “were always expected to reverse” as bond holdings were unwound and the overall gains and losses arising from the scheme were highly uncertain.