Why is the UK paying interest on the Bank of England loan ?

[350Matt]

So then peeps
as some may be aware apparently the country is very skint indeed, '22 billion black hole' etc

however during Covid the bank of England created a load of extra cash to keep cash flow going etc - however as its government money the government then pays the 5.25% base rate of interest on this created cash ?

this results in an interest payment of 22-35 Billion depending on how you add it all up ?

this chap lays it all out very well

https://www.taxresearch.org.uk/Blog/2024/06/07/the...

extracted from above


Before 2006 no interest was paid on any touch balances, although they were insignificant at the time.

When interest payments were first introduced, no one argued that the balances have to amount to hundreds of billions of pounds to be effective, and evidence from other central banks, such as the European Central Bank, has shown that interest need not be paid on all such sums.

So, why has such interest been paid? That is because two exceptionally powerful lobbies have argued for those payments.

One of those lobbies has been the commercial banks, who have profited considerably as a result. Even now I would argue that they are profiting by more than £35 billion a year as a consequence. At one point that gain exceeded £40 billion a year.

[Mrr T]

The first thing is it would be better if he knew what he was writing about.

[markh1973]

Mrr T said:

The first thing is it would be better if he knew what he was writing about.

that's usually true of Richard Murphy

[350Matt]

Mrr T said:

The first thing is it would be better if he knew what he was writing about.

so this isn't happening then ? as I've seen it reported elsewhere

for example
https://neweconomics.org/2023/11/government-could-...

I can see the argument for not scrapping it entirely and if the loan / reserve sum wasn't so massive it wouldn't be onerous perhaps reduce the interest to 2% instead of 5.25% ?

Edited by 350Matt on Thursday 26th September 15:48

[Mrr T]

350Matt said:

Mrr T said:

The first thing is it would be better if he knew what he was writing about.

so this isn't happening then ? as I've seen it reported elsewhere

It is but it's a lot more complex.

QE was designed to increase liquidity in the market. The BOE bought gilts, from banks, but banks where just the intermediary, they came from the long term owners. This pushed lots of money into some and they needed to put it some where. So they deposited with banks at relevant rates. Banks really did not want the money and capital meant lending it out to companies and other banks made it uneconomic. Easy answer deposit it with the BOE. The banks make a small mark up and with no capital it's worth it.

Also the BOE does not just sit on the deposit it lends it out or buys gilts. I think the BOE makes a small lose.

So if the BOE stops paying interest the banks will just withdraw the deposits and return the customer deposits. This will create real market problems because there are few other places to take the money. Also the BOE would lose the income it gets. So a small saving for tax payers while creating real market stress.

[isaldiri]

Mrr T said:

The first thing is it would be better if he knew what he was writing about.

I think you should listen to your own advice first and it would also be better if you knew what you were writing about.....

[Mrr T]

isaldiri said:

Mrr T said:

The first thing is it would be better if he knew what he was writing about.

I think you should listen to your own advice first and it would also be better if you knew what you were writing about.....

So tell me where I am wrong?

[350Matt]

Mrr T said:

. So a small saving for tax payers while creating real market stress.

thanks for the insight

however its that small is it? as the smallest amount of taxpayer bill I've seen is 22 billion pounds a year and as much as 33 billion pounds

I'd be quite pleased to find that down the back of the sofa

I'll not deny my understanding of bank currency deals like this is slight, but its does rather seem the bank of England is making more money on this deal than it should

halving the interest would yield a considerable saving which If I was chancellor scratching around for every penny and stopping winter fuel allowance to save a few million why isn't this being more closely scrutinised ?

[Vanden Saab]

350Matt said:

Mrr T said:

. So a small saving for tax payers while creating real market stress.

thanks for the insight

however its that small is it? as the smallest amount of taxpayer bill I've seen is 22 billion pounds a year and as much as 33 billion pounds

I'd be quite pleased to find that down the back of the sofa

I'll not deny my understanding of bank currency deals like this is slight, but its does rather seem the bank of England is making more money on this deal than it should

halving the interest would yield a considerable saving which If I was chancellor scratching around for every penny and stopping winter fuel allowance to save a few million why isn't this being more closely scrutinised ?

Because it was in the Reform party contract and Labour doing it would be such a major boost for the party that is already taking Labour votes by the bucketload it is entirely unthinkable for them.

[isaldiri]

350Matt said:

I'll not deny my understanding of bank currency deals like this is slight, but its does rather seem the bank of England is making more money on this deal than it should

halving the interest would yield a considerable saving which If I was chancellor scratching around for every penny and stopping winter fuel allowance to save a few million why isn't this being more closely scrutinised ?

The BoE is not making money from QE now - it's actually currently puking cash in billions. the government at the time when setting up the facility to enable quantitative easing explicitly gave a guarantee that the treasury would cover any losses so is obliged to dig up however many billion in order to do so.

Those losses are being racked up because the BoE is paying the bank rate ie 5% on reserves (variously held by the UK banking sector) while only receiving the (much lower) coupons on the gilts they bought with those reserves to enable QE with gilts now mostly worth much less while the BoE is trying to sell down the veritable mountain of gilts they had been required to buy previously.

Now obviously the government could simply change that guarantee and allow the BoE to shove losses into the balance sheet like the Federal reserve or the ECB do. the treasury could also require the Bank of England to change policy such that they move away from paying interest on reserves so the treasury no longer has to cover losses.

However there's a dose of moral hazard in doing so. The guarantee to cover losses was given initially for a reason - mainly so that it gave the veneer of QE not being simply a money printing exercise from the magic money tree to fund the government like in some tinpot third world country plus it allowed the government to cheerfully scoop up any profits previously when it was making money.

the other main reason is that the 'ample reserves policy' whereby the central bank pays interest on reserves has become the primary way the central banks (at least here in europe and the US) influences monetary policy. Moving away from that regime presumably would have some unintended consequences that no one particularly wants to risk, especially as the current policy has probably proven to be more stable than attempting to resize the absolute amount of reserves available as the BoE I believe used to do (pre financial crisis). It probably wouldn't help to reduce the losses that the treasury has to refund the BoE only to cause a wider problem overall by messing up the overnight funding markets used by the wider financial sector I'd suggest....

P.S while I've tried to minimise the financial jargon, do let me know if anything still remains too full of financial geekery and I'll try to reword it if unclear....

[Mrr T]

isaldiri said:

While you said I was wrong you still have not explained why. However, I do agree my response could have had more detail. I focused on reserve accounts held by the commercial banks because that what the link referred to. Also those have risen since QE.

However, if I am not mistaken, when the BOE carried out QE it did so by creating reserves but the reserves are not owed to the commercial banks. The total paid out on reserve accounts include that paid to commercial banks and that accused on the QE accounts which is retained by the BOE.

Happy to be corrected.

As to the loses on the APF bonds I was thinking about that I suggest it's a bit more complex. It's easier to explain with an example. 20 years issue at par paying fixed 5%. Rates fall to 1% and bond is now trading at 120 (I have not checked the prices). The government has an unrealized loss of 20 because it will be paying more than the market rate until redemption. Now I know the BOE does not MTM but the fact is it is a real cost to the government.

APF buys bond for 120 using money borrowed from the BOE creating 120 of QE. Rates are now 5% so the bond is now 100. If the APF sells the bond at 100. The treasury must now pay the loss of 20 because the BOE says it will fully reverse QE. However, the bond is now at par so there is no unrealized loss. So all that's really happen is the unrealized loss on purchase has been realised by the sale. So other than timing the position is the same.