The Treasury had to save the Bank of England from its first losses in its quantitative easing program since 2009, which were caused by a hike in official interest rates.
In figures published on Tuesday evening, the central bank reported that the Treasury had transferred £828m during the third quarter and that it expected these payments to continue for the foreseeable future.
The Office for Budget Responsibility showed in its forecasts in its autumn statement last week how sensitive total debt interest payments are to the Bank of England’s official interest rate, and this was fully reflected in its official forecasts.
Payments between the government and the central bank have no effect on total government borrowing because they are money movements within the public sector.
When the Bank of England began quantitative easing in 2009, the program was intended to buy government bonds, in part to lower the cost of long-term government borrowing and the long-term interest rates charged to businesses.
This initially made a huge profit for the Bank of England because the interest rate it was paying on the money created by QE to buy government bonds was being rewarded at the bank’s official rate, which was close to zero. In return, he was paid far more than the coupons on those bonds.
This profit was transferred to the Treasury and amounted to a cumulative cash flow gain of £122 billion by the end of September 2022.
But as the Bank of England raises interest rates to 3 per cent, it pays more to banks holding the money it created than to coupon payments on the £838bn of government bonds it still holds.
The Office of the Budget estimated in its autumn statement that the Treasury would need to pay £133 billion to the Bank of England over the next five years to cover these losses.
The FCA calculated that for the public sector as a whole, the effect of QE was to reduce the maturity of UK government debt from seven years before QE began in 2009 to two years because it turns long-term borrowing into overnight debt.
Richard Hughes, head of the balance sheet office, told MPs on the Treasury Committee on Tuesday that quantitative easing has significantly increased the sensitivity of the UK government’s debt stock to changes in official interest rates, which are now being quickly transmitted to the public finances.
The Office for Budget Responsibility has long warned that when the Bank of England raises interest rates, public finances will be more sensitive than in the past. It estimated that a one percentage point rise in interest rates across all maturities would force the government to increase debt interest payments by £25 billion a year.
“Almost half of the impact of interest rate hikes can be felt in a year’s time today, not just a quarter if the debt maturity structure of 2000-2001 still prevails,” OBR wrote in its assessment of last week’s fall statement.