The Treasury has had to bail out the Bank of England for the first losses it has made on its quantitative easing programme since 2009, which resulted from rises in official interest rates.
In figures published on Tuesday evening, the central bank reported that the Treasury had transferred £828mn during the third quarter and that it expected these payments would continue for the foreseeable future.
The Office for Budget Responsibility demonstrated in its forecasts at the Autumn Statement last week how sensitive the overall debt interest payments were to the BoE’s official interest rate and this was fully reflected in its official forecasts.
Payments between government and the central bank have no effect on total government borrowing because they are movements of money within the public sector.
When the BoE started QE in 2009, the aim of the programme was to buy government bonds, partly to lower the cost of long-term government borrowing and long-term interest rates charged to businesses.
This initially made a huge profit for the BoE because the interest rate it was paying on the money created by QE to buy government bonds was remunerated at the bank’s official rate, which was close to zero. In turn, it was paid much more from the coupons on those bonds.
This profit was remitted to the Treasury and amounted to a cumulative cash flow gain of £122bn by the end of September 2022.
But with the BoE raising interest rates to 3 per cent, it is paying more to banks that hold the money it created than the coupon payments on the £838bn of government bonds it still holds.
The OBR estimated in the Autumn Statement that the Treasury would need to pay the BoE £133bn over the next five years to cover these losses.
The fiscal watchdog calculated that for the public sector as a whole, the effect of QE has been 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, chair of the OBR, told MPs at the Treasury Committee on Tuesday that QE therefore significantly increased the sensitivity of the UK government debt stock to changes in official interest rates, which are now transmitted quickly to the public finances.
The OBR has long warned that when the BoE raised interest rates, the public finances would be much more sensitive than in the past. It estimated that a 1 percentage point rise in interest rates across all maturities forces the government to increase debt interest payments by £25bn a year.
“Nearly half the effect of a rise in interest rates is felt within a year today, rather than only a quarter if the maturity structure of debt in 2000-01 still prevailed,” the OBR wrote in its assessment of the Autumn Statement last week.