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Blimey, this is a bit scrambled

Officials have asked Parliament for approval to spend an additional £180bn covering losses on the Bank’s so-called quantitative easing (QE) programme. The disclosure is a sign that British households will be forced to cover massive losses as the stockpile of government bonds built up over the last decade and a half is sold down.

Umm, well

Losses are realised because QE created reserves held by commercial lenders in the form of deposits. Threadneedle Street pays interest on those reserves at the current Bank of England base rate. When interest rates were at record lows, the cost of paying interest was more than covered by the money earned on government bonds.

Now interest rates have climbed to 4pc, which is above the average interest rate earned on gilt holdings, the Bank is paying out more on QE deposits than it earns from bonds. The Treasury must step in and cover the difference.


Last November, the Bank started selling government gilts back to investors in an attempt to shrink its huge balance sheet. Policymakers have authorised sales of up to £80bn over the coming year.

Well, sorta.

There are two entirely different things happening here. One is that those central bank reserves now pay more in interest than the amount the Bank of England is receiving on those gilts it holds as part of QE. Well, there was that long period when it was getting more in interest than it was paying out. Swings and roundabouts and all that.

As the Bank sells off those QE bonds then the amount of central bank reserves will fall (and no, not back to pre-2007 levels, as we’ve pretty much used CB reserves to replace the overnight interbank markets) and so will any interest bill mismatch.

Then there’s the second part, which is that those QE gilts were issued in a lower interest rate environment than today. So, if the Bank sells now something issued a few years back there will be a capital loss on such a sale.

Whether the Bank is actually to sell gilts I don’t know. The Fed has said that it will allow bonds to mature and then won’t roll over those funds into new purchases. This is also known as holding to maturity and that means no such capital losses. There are still the same real losses, sure, but they arrive as opportunity costs and so don’t have to be accounted for. Don’t replace maturing bonds only as your method of QT and there are no such capital losses.

The two are very different. For example, you could reduce the interest loss by selling off more bonds more quickly and thereby increasing the capital loss (obviously) and also vice versa (also obviously).

But they are different things with different solutions.

Which does lead to a question, is BoE threatening to sell bonds or merely not to roll over maturing ones?

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