MNI INTERVIEW: UK Likely To Restore BOE To Debt Calculation
Resolution Foundation Research Director James Smith talks to MNI about the BOE and UK fiscal policy following July 4 elections.
The UK’s next government is likely to change its definition of public sector net debt to include the Bank of England’s balance sheet, allowing it to borrow an additional GBP16 billion in the 2028-2029 financial year whilst still meeting its fiscal rule for debt to fall as a percentage of GDP within five years, the research director at well-known think-tank Resolution Foundation told MNI.
Reincorporating the BOE into the definition of PSND should be an administratively straightforward if “pretty superficial” move, and could be made in the autumn budget planned by the opposition Labour Party, which is running around 20 percentage points ahead of the ruling Conservatives in opinion polls ahead of July 4 elections, James Smith said in an interview.
"You're going to bring a slightly different definition of debt down, rather than the underlying one that the government currently has. The new government could just announce this as part of their new fiscal framework ...I feel it's pretty likely that you'd make this change," Smith said. (See MNI INTERVIEW: UK Budget's Imaginary Cuts A "Fiscal Fiction")
The BOE was included in PSND calculations for the fiscal rules in 2019, but was later excluded in large part because of the distorting effect of its Term Funding Scheme providing large quantities of cheap loans to banks. Given that banks were highly likely to repay these loans on time, it was felt that this could provide a misleading impression of falling government indebtedness.
REMUNERATION ON RESERVES
The incoming government might also be tempted to put an end to remuneration of all BOE reserves, which are currently paid at Bank Rate, with a shift to a tiered reserve system cutting debt interest spending by up to GBP8 billion in 2028-29, said Smith, though he warned that such a move might be detrimental to financial instability and would be opposed by the BOE itself. (See MNI POLICY: BOE Steering Clear Of Reserve Remuneration Change)
"If you had a bank that was not faring particularly well, and then they also happened to be one of the largest holders of reserves, then that could exacerbate some financial stability issues ...You would want to be careful, there are definitely risks. I can understand why the Bank of England are pushing against this," said Smith, formerly a senior economist at the Bank.
"I always took the Bank to be more worried about this being a rather arbitrary tax on the banking system,” he said, though he acknowledged that the fact that remuneration on reserves is not widely understood by the public might add to the political appeal of any alteration to the current arrangements. The idea of ending full remuneration has been circulating in policy circles for several years, prompting BOE Governor Andrew Bailey to warn against it. (See MNI INTERVIEW: BOE Could Spark QT Woes Before Banks Expect)
"it's a messy policy choice, and I see why as ...(a) first, best taxation of the banking system, you'd be against this," Smith said.
However, he was not convinced by the objection that ending full reserve remuneration could make it trickier for the Bank to align its policy rate and short-term market rates.
"You don't need to pay interest on all your reserves in order to implement monetary policy ... You see other central banks implementing a tiered reserve system," he said.