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The UK's Office for National Statistics has had to look into how to account for the fiscal effects of post-QE higher interest rates.
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The UK Office for National Statistics is set to publish guidance on how it would record losses on the Bank of England’s vast stock of gilt holdings as rates rise, after years of quantitative easing which have effectively shortened government debt maturities, ensuring that higher interest rates will have an immediate fiscal impact, officials said.
Until now the BOE has channelled back to the Treasury profits it makes from the spread between coupon payments on securities in its Asset Purchase Facility and the interest it pays to banks on the reserves it used to buy the bonds. But a higher Bank Rate paid on the reserves will reduce these transfers, and, if the rate keeps on rising, would eventually reverse it.
Under an agreement with the BOE, the Treasury has promised to indemnify any losses made during QE, attracting the close attention of lawmakers. From an accounting perspective, however, any indemnity and corresponding loss would cancel each other out, as equivalent transfers between sectors of the public sector balance sheet, officials at the Office for National Statistics, which has prepared guidelines on how to account for the flows, told MNI. (See MNI INTERVIEW2:Altering BOE Reserve Payments May Backfire-Bean)
The fiscal impact of higher rates, though, would be another story, as a jump in rates could prompt the government to increase its borrowing as its interest payments rise, or to cut spending.
“Any losses which are incurred as QE unwinds will affect Public Sector Net Borrowing and the current budget deficit, and will push up Public Sector Net Debt excluding the Bank of England,” Philip Wales, head of the ONS's Public Sector Division, told MNI. “How this unwinds will therefore have an impact on the Government’s new fiscal mandate and supplementary measures.”
The Treasury’s new fiscal mandate is to aim for debt to fall as a share of GDP excluding BOE transactions. But if rising debt interest costs force it to increase borrowing, this ratio could rise, no matter whether the liabilities are meant to cover an indemnity to the Bank.
Under its tightening strategy, the BOE plans to stop reinvesting the proceeds of maturing gilts when Bank Rate, currently at 0.1, reaches 0.5% and then to consider selling them from 1.0%, both of which moves could result in a loss on the original market prices of the securities. These would then have to be accounted for.
The Office for Budget Responsibility has estimated that QE roughly doubled the proportion of debt that responds to interest rate changes within a year. This will save the public sector GBP17.1 billion in debt interest in the 2021-22 fiscal year alone, but the effect would reverse in a high interest rate scenario.
“Swapping interest payments on gilts for interest payments on Central Bank reserves has helped to keep public sector net borrowing low in recent years. But if interest rates rise, the flows we observe now could reverse,” Wales said. “Although the recording inside the public sector boundary is complicated, the real fiscal impact arises from the higher interest costs on the Bank of England’s reserves.”