(CTN News) – According to insights from Deutsche Bank, the Bank of England‘s anticipated losses resulting from bonds purchased to stabilize the UK economy following the 2008 financial crisis are expected to be significantly higher than initially projected until the mid-2020s.
The central bank’s Asset Purchase Facility (APF) program, spanning from 2009 to 2022, aimed to improve the financial conditions for businesses affected by the crisis. Over this period, the Bank accumulated £895 billion in bond holdings amidst historically low-interest rates.
In recent developments, the Bank of England began reversing this position, initially by discontinuing reinvestments of maturing assets and subsequently by actively selling bonds at an estimated rate of £80 billion annually starting from October 2022.
However, the acceleration of tightening monetary policies to curb inflation has led to more rapid cost escalation than initially forecasted. As interest rates climbed, the value of the purchased government bonds, commonly called gilts, diminished precisely as the Bank commenced selling them at a loss.
During July, public finance data indicated that the UK Treasury allocated £14.3 billion to the Bank of England to offset losses from its quantitative easing program. This figure exceeded the projection outlined by the independent Office for Budget Responsibility in March by £5.4 billion.
Deutsche Bank’s senior economist, Sanjay Raja, highlighted that since September, a total of £30 billion has already transferred from the Treasury to the central bank. Raja anticipates that these indemnities will likely persist above the government’s estimates for two main reasons.
Firstly, interest rates have surged well beyond levels initially factored into fiscal predictions. Secondly, the decline in gilt prices, especially in the longer end of the market, has deepened the valuation losses as the Bank actively unwinds the APF through bond sales.
The Bank of England has implemented 14 consecutive interest rate hikes in its monetary policy meetings, elevating its benchmark rate from 0.1% in late 2021 to a 15-year peak of 5.25%. The market anticipates a 15th hike to 5.5% during the next Monetary Policy Committee meeting.
Imogen Bachra, head of U.K. rates strategy at NatWest, noted that the impact on public finances is twofold. Firstly, losses are incurred when the Bank of England’s gilts are sold at a price lower than their purchase price, which was acquired during a period of falling rates.
Secondly, the Bank pays interest on the approximately £900 billion reserves created for gilt purchases. The rise in the Bank Rate amplifies this interest expense.
The burgeoning costs resulting from this situation could impede the government’s capacity to pledge public spending or tax reductions before the 2024 general election.
The Bank of England’s surplus generated from printing banknotes or trading bonds beyond capital buffers is typically transferred to the Treasury for public spending purposes.
Deutsche Bank’s assessment encompassed the expected net interest costs on central bank reserves and the deteriorating value of APF bonds when the Bank crystallizes losses by selling or redeeming them.
Raja concluded that the Treasury’s cost of indemnifying the central bank over the next two fiscal years will surpass previous forecasts by approximately £23 billion.
This equates to £48.7 billion for the present fiscal year and £38.1 billion for the subsequent year, before declining notably in the following two years in tandem with falling bank rates and the gradual depletion of the APF stock.
While inflation exceeds expectations, the additional burden of indemnity costs from the Bank’s operations will likely pose a challenge for Finance Minister Jeremy Hunt’s autumn budget statement.
However, the stronger economy over recent months may offset these concerns, resulting in overall borrowing potentially remaining below the Office for Budget Responsibility’s projections.