More and more problems are emerging with the QE programme the Bank of England presented as a triumph

Last night brought some bad news for the QE programmes employed by the world’s central banks and ironically it came from the world’s main central bank.

The Federal Reserve has signalled that US borrowing costs are likely to remain higher for longer, as it wrestles with persistent inflation across the world’s biggest economy. ( Financial Times)

Actually I think that “higher for longer” was in fact used simply for PR so there is rather in an irony in it becoming true. But where this causes a problem is in the nature of QE (Quantitative Easing) bond buying.

1. You invest at a fixed interest rate or coupon
2. You pay for it at a variable interest-rate ( Bank Rate in the UK)

Another way of looking at the rises in interest-rates to deal with the inflationary surge is that it raised the cost base for QE. Remember this was considered at the time to be an establishment triumph as the central banks made a carry profit out of this.We can look at that world via the Bank of Japan which still lives in it.

First, the Bank’s income has been on an increasing trend. Interest income on the government bonds has been rising following the increase in the purchases of long-term JGBs.

That is my part 1 above and now let me bring in part 2

 in line with the developments on the asset side, there was a substantial rise in current deposits on the liability side, in the form of an increase in financial institutions’ excess reserves. In order to control short-term interest rates at the target level in the presence of such large excess reserves, it became necessary to apply interest rates on excess reserves. ( Governor Ueda Swptember 2023)

That policy has led to costs in other areas as last night’s intervention to support the Yne shows. But in terms of QE the Bank of Japan is still in the financial masters of the universe phase. Let me now bring that back to the Bank of England. Having set a Bank Rate of 0.1% they were willing and able to charge into the UK government bond market. I argued at the time they acted like headless chickens and it was their own 0.1% Bank Rate which made them think that buying the benchmark UK bond at 0.5% was a stroke of genius.

Group Think

Back in August 2020 Bank of England Governor Andrew Bailey gave himself a big slap on the back at Jackson Hole.

But, if this result proves robust, it suggests that “going
big and fast” with QE is particularly effective in these conditions.

It did not occur to him to wonder why no-one had done it before.

For many central banks, the main
tool to date has been further Quantitative Easing, in unprecedented scale and pace of purchases.

Later in the speech once the trumpet blowing was over we were told that reversing it (QT) would be a mere detail.

The MPC has considered its prospective approach to QE unwind in recent years, and in June 2018 set out
that the balance sheet would be unwound at a gradual and predictable pace, allowing reserves to fall back to
a level demanded by banks through their participation in regular repo operations, and once the Bank Rate
had risen to around 1.5%, thus creating more headroom for the future use of Bank Rate both up and down.

I would like to draw your attention to the Bank Rate quoted and this is where the group think comes in. Central bankers were unable or unwilling to think of any scenario where QE would go wrong and leave them with egg on their faces. In my opinion 1.5% was not chosen out of any view on what was likely for interest-rates but because it was a level where the Bank of England was expected to start making losses.

Yet even even what in Dune terms might be described as a “Golden Path” was dismissed by Governor Bailey.

The MPC keeps this approach under review, though I should make clear that it does not seem like an
imminent issue in current conditions.

The reality is that Bank Rate is now 5.25% and the trumpet blowing now looks like a combination of hubris and incompetence.

The Precious! The Precious!

One of the themes of the credit crunch era has been the extraordinary efforts made on behalf of the banks. Now let me continue the saga above via a report from the Treasury Select Committee which shows another example of this. The emphasis is mine.

Under quantitative easing, the Bank of England created £895 billion of new money in the form of central bank reserves held by commercial banks, of which around £700 billion remains in circulation. The Bank pays interest on those reserves at Bank Rate, currently 5.25%. This has generated considerable income for banks as a result of the sharp increase in interest rates since 2021. The Treasury is ultimately liable for these payments as it indemnifies the QE programme.

We can look at that in more detail.

Information about our interest income is published in Barclays Bank UK Annual Report.
Recently published figures associated with interest generated from cash held at the central
bank are £819m (2022) and £1,878m (2023).

NatWest earned approximately £2.85bn (2023) and £1.64bn (2022) interest income on
its central bank reserves net of TFSME interest payments to the Bank of England.

The Financial Times has added up the numbers as shown below.

NatWest, Barclays, Lloyds and Santander collectively received £9.23bn in interest on deposits held by the central bank in 2023, more than double what they had earned the previous year, according to figures published by the House of Commons Treasury select committee.

Some seem to be treating that as a total which rather forgets HSBC and all the other banks.

Comment

As you can see the claimed triumph of QE is leading to more and more problems. One way of looking at it comes from the fact that we are still mired in an era of low/no economic growth in return for all the borrowing and central bank largesse. Many will consider themselves to be worse off after the severe cost of living crisis we have been experiencing.

Personally I think that the numbers quoted by the banks above are an understatement and let me show why. The current stock of bonds is £704 billion and at a Bank Rate of 5.25% that suggests the gross payments on the Asset Purchase Facility are around £37 billion per year. One route the numbers were massaged above was the way Nat West deducted payments under the Term Funding Scheme.

Another way of looking at this comes via the public finances.

The borrowing of both subsectors is affected by payments totalling £44.4 billion made by central government to the BoE over the last twelve months under its Asset Purchase Facility Fund (APF) indemnity agreement.

Care is needed as profits of £120 billion were booked, but as you can see they are disappearing pretty quickly.

The group think madness continued an issue some of you may recall. Back in the days of Dame Minouche Shafik the Bank of England considered interest-rates of 0.5% and 1% to be significant for QT. You may recall also that she was so incompetent that she was moved on before the end of her term to save further embarrassment. So we have the interest-rate madness as well as the way that these people just move on. Guess where she is now? It has been in the news rather a lot.

Nemat (Minouche) Shafik became the 20^th president of Columbia University on July 1, 2023. President Shafik is a distinguished economist who for more than three decades has served in senior leadership roles across a range of prominent international and academic institutions.