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Should the Bank of England Adopt Unremunerated Reserve Requirements? - NIESR
Quantitative Easing (QE) involved central banks making large scale purchases of fixed interest bonds, in exchange for crediting commercial banks’ current accounts held at the central bank ？ “reserves” ？ with the aim of delivering economic stimulus by expanding the money supply and lowering long-term interest rates. In the United Kingdom, since 98 per cent of the bonds purchased by the Bank of England (BoE) were gilts, and the state-owned BoE pays interest on reserves at the BoE’s monetary policy rate, known as “Bank Rate”, QE effectively meant the state buying back its own fixed interest debt in return for floating rate state debt, with the market taking the other side of that trade. Naturally, that switch exposed the state to interest rate risk, in terms of the potential for both realised losses, when Bank Rate exceeds the yield locked in by the price paid for the bonds, and mark to market losses on the bonds.
Throughout the period while the BoE was making QE bond purchases and until about two years ago, Bank Rate stood below bond yields, so QE was consistently generating net cashflow into the BoE QE portfolio, with the cumulative cashflow peaking at ？124 billion in mid 2022. In order to insulate the BoE from any profit or loss arising from QE, HM Treasury (HMT) agreed to become the beneficial owner of the BoE QE portfolio, and HMT withdrew the accumulating cash to fund public expenditure.
However, the surge in inflation from late 2021 onwards prompted a steep rise in Bank Rate to 5¼ per cent. Although the stock of reserves created by QE has been reduced from its peak level of ？895 billion by some bond maturities and quantitative tightening (QT) bond sales, it still stands at ？728 billion. At that level of reserves, and with the yield locked-in on the remaining bonds at about 2 per cent, the 3¼ percentage point difference between Bank Rate and gilt yields obliges HMT to pay cash back into the QE portfolio, at a rate of about ？24 billion per year, equivalent to about 2 per cent of total government revenue. Not surprisingly, analysts are suggesting ways to reduce that net interest outlay.
Throughout the period while the BoE was making QE bond purchases and until about two years ago, Bank Rate stood below bond yields, so QE was consistently generating net cashflow into the BoE QE portfolio, with the cumulative cashflow peaking at ？124 billion in mid 2022. In order to insulate the BoE from any profit or loss arising from QE, HM Treasury (HMT) agreed to become the beneficial owner of the BoE QE portfolio, and HMT withdrew the accumulating cash to fund public expenditure.
However, the surge in inflation from late 2021 onwards prompted a steep rise in Bank Rate to 5¼ per cent. Although the stock of reserves created by QE has been reduced from its peak level of ？895 billion by some bond maturities and quantitative tightening (QT) bond sales, it still stands at ？728 billion. At that level of reserves, and with the yield locked-in on the remaining bonds at about 2 per cent, the 3¼ percentage point difference between Bank Rate and gilt yields obliges HMT to pay cash back into the QE portfolio, at a rate of about ？24 billion per year, equivalent to about 2 per cent of total government revenue. Not surprisingly, analysts are suggesting ways to reduce that net interest outlay.
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