When Labour made the Bank of England independent in 1997, the idea was that the Bank set interest rates while the Treasury taxed and spent. Monetary policy was in Threadneedle Street, fiscal policy in Whitehall. But in August the Bank of England quietly slipped out that its key policy could cost the Treasury £120bn. That policy – quantitative tightening (QT) – clearly ought to be rethought and the policy of the Treasury indemnifying the Bank for its losses ended. Last year, ministers paid the Bank £17bn to cover these arguably notional losses – an amount considerably larger than the budget of the Ministry of Justice, which is dealing with a real prisons crisis.
Bank independence was constructed for a world in which monetary policy decisions had predictable and indirect fiscal effects. The financial crisis, Covid, war and fractious trade disputes have contributed to ending that world. The Bank bought up government bonds to support the economy via its quantitative easing (QE) programme. But the constitutional settlement – of an independent central bank working out on its own what to do with those bonds – has not caught up. The game is surely up when a former Bank deputy governor, Charlie Bean, acknowledges that independence cannot justify effectively giving power to an unelected monetary policy committee (MPC) over decisions with great consequences for public spending.
The Treasury stands behind the losses – and gains – made by the bonds bought during QE and held in a Bank of England subsidiary, called the Asset Purchase Facility. The losses are being produced in three ways. First, the Bank is selling these gilts at current market prices. Because their yields are higher than when QE was operating, the gilts are worth less than the APF paid for them. Second, the APF generates a loss because the £500bn bonds on its balance sheet generate less income than the repayments, charged at the base rate, on the “loan” it took to buy them. Third, gilts bought above their value are booked as a loss when they mature.
Labour created the indemnity after the 2009 crash. But it was George Osborne who turned it into a quarterly cash machine in 2012. When rates were low, the Treasury profited to the tune of £124bn. Once rates rose, the same mechanism went into reverse – and because it is an uncapped indemnity, even when the windfall has been repaid the Treasury carries on paying the Bank.
Ministers should end this arrangement. No other major central bank carries on in this way. Whatever one thinks of the losses, making the Treasury settle them immediately turns monetary choices into fiscal interventions. A report this week says that the Bank and Treasury are drawing up changes to QT to reduce pressure on raising interest rates. Independence seems to have been discarded in favour of quiet coordination. The MPC’s decisions cannot be beyond challenge.
Andrew Bailey, the Bank’s governor, calls the overall cost of QT “neutral” – but only, as the economist Patricia Pino points out, when assessed over six decades. In fact, billions in cash demands fall within a parliament. Governments do not set budgets, fight elections or run public services over 60 years. It is unsustainable for the Bank to make decisions and have ministers face voters for the political consequences.
