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Monday, May 20, 2024

Bank of England forecasts 150 billion pound loss from QE gilt programme

The Bank of England forecast on Tuesday that it would make a net loss of just over 150 billion pounds ($193 billion) over the next 10 years as it unwinds its quantitative easing (QE) gilt purchases, up from 100 billion pounds projected in April.

That loss will need to be funded by the government, at a time when public finances are already under pressure from rising interest rates and inflation, and members of Prime Minister Rishi Sunak’s Conservative Party want tax cuts before a likely 2024 election.

In the short term, the BoE expects the government to pay around 40 billion pounds a year in 2023, 2024 and 2025, roughly 10 billion pounds a year more than its last estimate in April.

Under the terms of the QE programme, which started in 2009 as a means to stimulate the economy after the global financial crisis, Britain’s finance ministry effectively received back the interest payments on government bonds bought by the BoE, but agreed to compensate it for any future losses.

Between 2009 and 2022, the BoE paid the government 124 billion pounds, representing the difference between the interest the BoE received on government bonds it had purchased and the near-zero interest rate it paid on cash deposited by the banks from whom it had bought the bonds.

The BoE forecasts are highly sensitive to changes in financial markets’ interest rate expectations and how fast it sells the 875 billion pounds of British government bonds it bought from 2009 to 2021.

Higher BoE rates reduce the market value of the gilts it holds and increase the interest it pays to banks, which has risen from 0.1% in December 2021 to 5% as of June.

Markets currently expect BoE rates to peak at 5.75% later this year, up from around 5% at the time of April’s report.

Last year two former BoE deputy governors suggested the BoE and the government should consider stopping paying interest on some of banks’ holdings with the BoE, but this was rejected by BoE Governor Andrew Bailey.

So far the BoE has reduced its gilt holdings to just over 800 billion pounds through a mix of outright sales and not reinvesting the proceeds of maturing gilts.

The BoE projections assume holdings continue to fall at their current target rate of 80 billion pounds a year.

Under a separate scenario, where interest rates settle back in line with a 2018 BoE estimate of their equilibrium level of 2-3% – which is lower than markets expect – losses are reduced to just over 100 billion pounds. That is still more than 50 billion pounds greater than forecast in April.

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