MNI INTERVIEW: BOE Needs To Change Reserves Regime - NEF

The Bank of England should begin absorbing losses created by quantitative easing by abandoning its government indemnity, saving the Treasury up to GBP20 billion a year, a senior economist at a prominent left-wing think-tank told MNI. 

The costs of QE -- including reserve remunerations – are currently offset by the indemnity, introduced by former Chancellor of the Exchequer George Osborne in 2012, but the New Economic Foundation’s Dominic Caddick said the government could end the agreement if it so wished, even if it is unlikely to do so in the upcoming budget.

“As easily as it was done then, the Treasury could change the indemnity so current costs are not putting so much pressure on Chancellor Rachel Reeves in meeting her fiscal rules,” Caddick said in an interview, noting that when the agreement was introduced QE was profitable and helped Osborne meet his fiscal rules.

While QE passed profits of around GBP120 billion to the government through 2021, the rise in interest rates from 2022 has since cost a total GBP80 billion and looks set on its current course to cost a further GBP20 billion a year through 2033, according to the NEF.

The BOE currently remunerates central bank reserves at Bank Rate, and the opposition Reform and Green parties are already calling for this payment to be reduced to nothing. A shift to a tiered system in which a new minimum reserves requirement is unremunerated or remunerated at lower levels would also save money. (See MNI INTERVIEW: Banks Helpless Against Any BOE Reserve Change)

BUDGET MEASURES

For the moment, though, Caddick said Reeves is more likely to add to the existing Bank Levy than to alter the BOE’s remuneration structure, as she turns to the banks to help fill her estimated GBP30 billion fiscal black hole.

“Just putting a few percentage points on [the bank levy] is probably going to be the most likely, the most plausible option,” to raise cash from the banking system, he said. However, Caddick noted that that would mean the government would continue to tax banks on profits made from the easy pickings of reserve remunerations rather than to directly address the source of that profitability.

“Their intellectual thinking is ‘the reason we should do this tax is because these banks are getting lots of money through reserve payments right now. Lets design a tax to target their reserve profits,’” Caddick said.

Both the European Central Bank and the Swiss National Bank operate tiered reserve systems, with minimum reserve requirements of 1% and 4%. Caddick and the NEF have calculated that implementing equivalent systems in the UK would save GBP1.3 billion or GBP5.3 billion per year respectively.

BOE policymakers have made clear their opposition to any change in the reserves regime, which is the basis for transmission of their monetary policy, but Caddick said a move away from the current system is likely to occur soon, putting to an end to what he called “monetary dominance” in which central bank decisions directly constrain fiscal policy.  (See MNI INTERVIEW: Ex-BOE Markets Head Doubts Mass Repo Tactic )

MONETARY POLICY IMPLICATIONS

Caddick argues that a change in the BOE’s operational framework would actually benefit its monetary policy-making ability, and that that would be sufficient reason for change even without any boost for the fiscal position

“One thing that I think has been lost in the remuneration debate is that there is a monetary policy argument to tiered reserves,” he said.

“There are a few papers out there suggesting if you give banks this sort of windfall profit, they're actually going to be less sensitive to the dynamics of interest rate changes, because their balance sheets are protected, and therefore they don't have to be as competitive.”