How should Britain handle £200bn in quantitative-easing losses?
Plenty of traders have lost millions on ill-timed forays into bond markets. A sorry handful have even lost billions. Losing hundreds of billions, though, is the preserve of governments. In Britain the bill for the Bank of England’s losses from its quantitative-easing (QE) programme since interest rates began to rise is projected to hit around £200bn ($254bn, 7.4% of GDP). The government’s approach to these losses, and their messy interaction with Britain’s fiscal rules, could determine whether Britons face tens of billions of pounds more in tax rises at the next budget, due for the end of October.
Like most of its peers, Britain has leant heavily on QE—whereby central banks stimulate the economy by creating money (in the form of bank reserves) and buying assets (most often, long-term government bonds)—since interest rates fell to near-zero during the 2007-09 financial crisis. The result is to lower bond yields and boost liquidity—stimulating more borrowing and growth—and to leave central banks sitting atop balance-sheets stuffed with bonds.
Whether central banks turned a profit on those holdings was, until recently, mostly an irrelevant question. The goal of QE was to juice the economy, not make a profit. And in any case, things worked out well. Swapping reserves for bonds is, in effect, a bet on lower interest rates. In the 2010s central banks were usually on the right side of that trade. QE helped push yields down (meaning bond prices rose) and an anaemic economy kept them low. The Bank of England made £124bn this way between 2009 and 2022, all sent to the Treasury (see chart).
More recently, however, the bet turned sour. Bond yields jumped in 2022; valuations cratered and central banks began paying more out in interest on reserves than they received on the bonds they held. In America the Federal Reserve treats QE losses as a “deferred asset”, which can sit on its balance-sheet indefinitely. That doesn’t eliminate the fiscal impact: future QE gains or seigniorage, income from issuing currency, would go to paying off the deferred asset rather than to the Treasury. But it does spread the pain and prevent a big upfront payment. Britain’s accounting rules mean that the Treasury must send cash to the central bank as losses crystallise, whether from negative cashflow or from selling bonds at a loss.
Current plans have the Treasury paying £20bn or so a year until 2032. These commitments collide unpleasantly with Britain’s main fiscal rule: that debt should be falling as a share of GDP in the final year of a five-year forecast horizon. In effect, therefore, the payments knock £20bn off the government’s room to borrow. That is a big number; the last budget, in March, left the government with just £8.9bn in fiscal headroom. Ms Reeves has since spent more than that on public-sector pay rises. The previous government’s plans also included around £30bn in future public-service cuts, which many find implausible.
Ms Reeves has plenty of incentive to soften the fiscal impact of those QE losses, in other words. How might she do so? The most logical answer would be to tweak the Bank of England’s accounting rules to a deferred-asset approach, along the lines of the Fed. A recent paper by Jack Meaning (an economist at Barclays, a commercial bank, and a former Bank of England official) and his colleagues explains that this would require legislative changes to allow the central bank to retain seigniorage, which could provide a flow of cash to gradually pay back the loss.
A simpler option would be to tweak the definition of debt used in the fiscal rules to exclude the losses from QE or alter the timing of when they enter the debt numbers. In a pre-election interview Ms Reeves said she would retain the current definition but recently she has sounded more open to changes. Politically, editing the terms of self-imposed rules may be more straightforward than meddling with the Bank of England’s mandate. Since Labour ruled out most of the more painless ways to raise taxes during the election, temporarily higher borrowing would beat a mishmash of distortive tax increases or cuts to investment. So let Ms Reeves off if she fiddles once—but not if she makes a habit of it. ■
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