Taxpayers might be on the hook for a £95bn bill as the Bank of England unwinds its programme of bond buying, new forecasts suggest.
The latest estimate, released today by the Bank of England in a quarterly update, is a slight increase on its previous upper estimate of £85bn, although down from around £150bn this time last year.
The Bank cautioned that the figure was “highly uncertain” as it depends on how interest rates change. The lowest estimate provided was £45bn, unchanged on its last forecast.
The cost results from the reversal of quantitative easing (QE), a tool of monetary policy in which the central bank buys government bonds from banks and other financial institutions.
The Bank of England started using QE in the aftermath of the 2008 banking crisis as policymakers attempted to stimulate economic activity. It engaged in two further rounds of QE after the Brexit referendum and during the pandemic, which brought its total stock of bond purchases to £895bn.
The Bank is now in the process of reducing the size of its balance sheet, a process known as quantitative tightening (QT). Near the end of June, the Bank’s total stock of assets was £695bn.
However, the increase in interest rates means the scheme will cost taxpayers tens of billions.
To buy the bonds from financial institutions, the Bank created new commercial bank deposits on which it had to pay interest.
When interest rates were low, the yield the Bank received from government bonds exceeded the interest it had to pay on new commercial bank deposits. As the Bank Rate has increased, however, the Bank of England has to pay out more in interest than it receives in gilt yields.
Unusually among central banks, the Bank of England is also actively selling government bonds back into the market. This crystallises a loss on those bonds, which fell in value as interest rates increased.
The Treasury has to transfer the Bank of England funds to meet these costs, which has become increasingly politically controversial.
In a recent report, the influential Treasury Committee drew attention to the costs of the scheme, suggesting it was “highly anomalous” that huge sums of public money were spent without normal value-for-money considerations.
During the election campaign, some commentators suggested that the Bank of England should stop paying interest on commercial bank deposits to help limit the cost. This proposal has been rejected by Chancellor Rachel Reeves.
The Bank of England will make a decision on the pace of QT in its September meeting, with most economists expecting that the Monetary Policy Committee (MPC) will green-light another £100bn in bond sales.
In its most recent forecast, the Bank said that QT has only had a “small impact” on gilt yields. Bank staff estimate that QT may have added 10-20 basis points to term premium in gilt yields.