Bank of England's QT policy could cost Treasury £120bn

The Bank of England's quantitative tightening policy could cost the Treasury up to £120 billion. The central bank revealed this potential cost in August, with ministers paying £17 billion last year to cover losses from the program.

This arrangement stems from the quantitative easing undertaken after the 2008 financial crisis. The Bank purchased government bonds to support the economy. Now, as it sells those bonds and raises interest rates, the policy is generating substantial losses for the Treasury. The indemnity, which guarantees the Bank against losses, was established by Labour after the 2009 crash and expanded by then-Chancellor George Osborne in 2012.

How the losses are generated

Losses are being produced in three distinct ways. First, the Bank is selling government bonds, or gilts, at current market prices. Since yields are now higher, these gilts are worth less than the Asset Purchase Facility paid for them. Second, the bonds generate less income than the repayments on the reserves created to buy them. Third, gilts bought above their face value are booked as a loss when they mature.

When interest rates were low, the Treasury profited by £124 billion from this mechanism. Now that rates have risen, the flow has reversed. Because the indemnity is uncapped, the Treasury continues to pay the Bank even after the earlier windfall has been repaid.

A challenge to central bank independence

Critics argue this setup blurs the line between monetary and fiscal policy. Former Bank deputy governor Charlie Bean has acknowledged that independence cannot justify giving an unelected committee power over decisions with major consequences for public spending. The editorial states that making the Treasury settle losses immediately turns monetary choices into fiscal interventions.

Bank of England Governor Andrew Bailey calls the overall cost of quantitative tightening "neutral." However, economist Patricia Pino notes this assessment only holds when viewed over an extremely long timeframe of six decades. The cash demands of billions fall within a single parliamentary term.

Calls for reform and coordination

A report this week indicates the Bank and Treasury are drawing up changes to quantitative tightening to reduce pressure on raising interest rates. This suggests a move away from strict independence toward quiet coordination. The editorial argues the current situation is unsustainable, allowing the Bank to make decisions while ministers face voters for the political consequences.

No other major central bank operates with a similar uncapped indemnity from its finance ministry. The editorial concludes that the policy of the Treasury indemnifying the Bank for its losses should be ended.