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UK's Financial Manoeuvrability: Chancellor May Gain Billions from BOE's Bond Sale Strategy Shift


Michael Chen

May 8, 2024 - 04:31 am


Potential Fiscal Leeway: UK's Chancellor Could Harness £10 Billion From Halting BOE Bond Sales

According to recent disclosures from the Bank of England (BOE), if the central bank were to cease the selling of bonds bought over more than a decade under quantitative easing, UK Chancellor Jeremy Hunt could find himself with an additional £10 billion a year to allocate for tax reductions. This fiscal breathing room comes as the BOE unwinds its asset portfolio, which swelled to £895 billion ($1.1 trillion) amid efforts to shield the UK economy from both the global financial crisis and the subsequent pandemic.

The UK's central banking authority has been in the process of decreasing its quantitative easing (QE) portfolios, a progression known as quantitative tightening (QT). Unlike most central banks that are allowing their assets to simply reach maturity, the BOE stands out for its active approach in selling off these assets.

In a revelation communicated through a letter to the Treasury select committee in December of the previous year, BOE Governor Andrew Bailey indicated a substantial fiscal reprieve for the government. If active bond sales were halted, the government would amass savings that amount to £100 billion by the year 2033, with the savings distributed approximately equally throughout the decade.

This pause in active asset selling would endow Chancellor Hunt with an additional £10 billion per annum. This is on top of his existing £8.9 billion fiscal headroom recognized at the March budget. Hunt has already made significant reductions to employee National Insurance contributions (NICs) by 4% since November of last year and harbors aspirations to completely abolish the tax.

UK Chancellor Jeremy Hunt

Last week, a startling financial burden surfaced as the BOE disclosed that the UK taxpayer is facing a £115 billion charge. This figure represents the lifetime losses associated with the QE program, originating from an agreement struck in 2009. The losses emanate from the discrepancy between the higher interest rates the bank paid on the money created to fund QE and the lower returns earned on the purchased bonds.

The future of the BOE's QT strategy is anticipated to be announced on September 19. At present, the bank's initiative to reduce the asset portfolio by about £100 billion each year demonstrates a keen intent to establish fiscal space should QE be required anew. Foregoing active sales for a purely passive strategy suggests the final bond within the portfolio would not reach maturity until the year 2073.

Chancellor Hunt appears to be planning a final fiscal statement in September, possibly preceding an October general election. Within his fiscal arsenal, both income and property tax cuts are considered viable options to fortify the Conservative Party’s position. The party is currently lagging behind the Labour opposition by approximately 20 points in opinion polls and witnessed significant defeats in the recent local elections.

However, the timeline for modifying QT strategies may indeed be constrained. For the Chancellor's policies to proceed, the Office for Budget Responsibility must confer its approval at least a week before any fiscal event is scheduled. Alternatively, should the political tides change, a future Labour-led government could stand to reap the benefits from a shift in policy.

The decision to halt active bond sales may be further influenced by when the BOE chooses to reduce interest rates. As active sales serve to tighten monetary conditions, they would be at odds with any rate reductions aimed at loosening financial conditions. Market expectations almost fully integrate a first quarter-point reduction from the current rate of 5.25% by August, with a reduction fully anticipated come September.

Sanjay Raja, the Chief UK Economist at Deutsche Bank, predicts that the bank will terminate active sales in September due to the counterproductive effect of active QT on financial conditions, which could undermine the bank’s main monetary policy tool. Confirmation of this perspective comes from Imogen Bachra, the Head of UK Rates Strategy at NatWest, who also supports the cessation of active sales this coming September.

Raja further elaborates that theoretically, eliminating the active component of QT could provide the Chancellor with the much-needed fiscal latitude for budget adjustments. He validates the £10 billion figure estimated in the BOE report as an accurate representation of the potential annual savings.

Furthermore, a spokesperson for the Treasury challenged the premise that slowing the pace of bond sales would reduce overall costs. Instead, they suggest that such a policy shift would simply extend the timeline and consequently elevate interest costs.

Despite the Treasury's skepticism, the BOE's preferred metric—"net present value”—illustrates that terminating active QT may be more economically viable than continuing with the current practice. This perspective is also shared by members of Parliament, who have voiced their encouragement for the BOE and the Treasury to prioritize value for money when determining the future of QT arrangements.

Christopher Mahon, the Head of Dynamic Real Return at Columbia Threadneedle Investments, argues that the potential fiscal relief for Hunt might actually be understated at £10 billion. Mahon posits that active bond sales are inflating long-term borrowing costs for the government by 0.4%, a figure that surpasses the BOE's estimation of an impact ranging from 0.1% to 0.15%.

Supporting this assertion, Tomasz Wieladek, the Chief European Economist at T. Rowe Price Group Inc., concurs that the costs inflicted by active sales on government borrowing are probably more substantial than the BOE's projections. If the real impact reaches 0.25%, terminating active sales could save the government an additional £600 million each year, according to Mahon's estimates.

In light of these discussions, the Bank of England maintained discretion and declined to comment further on the matter.

This informative article builds upon the original report provided by Bloomberg L.P. For more details on the matters discussed here, please refer to the specific disclosures made by the Bank of England.

Continuing the Conversation

While this article has offered a comprehensive overview of the potential financial outcomes of halting the BOE's active bond sales, the debate around quantitative easing and tightening continues to evolve. As we edge closer to pivotal dates such as the BOE's announcement on September 19, the Chancellor's potential fiscal statement, and the general election in October, the economic ramifications and strategic decisions made by the UK authorities will become more consequential.

Policy Implications and Political Dynamics

Chancellor Hunt's fiscal strategy, to be potentially revealed in September, could define the economic trajectory of the UK as it navigates post-pandemic recovery and ongoing financial challenges. The choices made in regards to QT and tax policy not only affect the Conservative Party's political standing but also have wide-reaching implications for UK taxpayers and the overall health of the national economy.

Economic Projections and Market Reactions

Investors and economists alike await the BOE's directional cues on interest rates and QT adjustments. The intricate balance between monetary policy, fiscal decisions, and market stability underpins the delicate process of ensuring the UK's continued economic resilience. As such, the coming months will be critical for financial forecasting and strategic planning among market participants.

Conclusion: Navigating Complex Financial Waters

The potential cessation of the BOE's active bond sales epitomizes the complexities embedded in modern financial policy-making. With the possibility of granting Chancellor Hunt an extra £10 billion annually for tax cuts, the discussions and decisions around QT are not merely about technical economic processes but fundamentally about shaping the UK’s financial future.

(For further information, refer to the Bloomberg report at: [BOE Disclosures]