Economists can become excited about identifying 'policy errors' made by central banks.
I have been quite animated about how the Bank of England was slow to react to the inflationary problem, such that an initial supply-side shock to prices broadened out to be a much more endemic phenomenon.
This has led to interest rates having to be raised far higher than they would have been if the BoE had reacted sooner. However, I get particularly animated about the probable losses that will arise from the unwinding of quantitative easing.
When QE first began, after the global financial crisis, it was not expected to have such longevity.
Due to interest rates at the time being lower than the yield on the gilts purchased, the BoE started generating profits within its asset purchase facility (APF).
By the latter months of 2012, enough profit had accumulated that an arrangement was made to transfer the gains to the Treasury.
While these profits were beneficial to the public purse, it was always anticipated that any losses the BoE incurred on the APF would result in cash flows back out from the Treasury.
Indeed, in his letter to then-chancellor of the exchequer George Osborne in November 2012, the former BoE governor Mervyn King said that “under reasonable assumptions it is likely that the majority of any transfer of funds to the government will eventually need to be reversed”.
The reason the Treasury would have to send money to the BoE is that the APF has been fully indemnified by the government against any losses.
Obviously, while gilt yields were low and interest rates were close to zero, the gilt portfolio owned by the APF was profitable.
The peak of the cumulative total of the transfers from the APF to the Treasury was £123.8bn in September 2022.
The rise in interest rates and gilt yields since has reversed the direction of flows.
Firstly, this is due to the yield on the APF portfolio being below base rates.
Secondly, there are mark-to-market losses being crystallised as the BoE sells gilts as part of its quantitative tightening programme.
Finally, there are administrative costs of the scheme, but these pale into insignificance compared to the other two factors.
Details on the APF are updated quarterly, along with projections for the profits or losses likely to be generated.
Gilt holdings peaked at £875bn; by the end of June 2023 they were down to £803bn, albeit that is using initial purchase price valuations, not where the market values them now.
The chart below shows the cash flows between the APF and the Treasury.
The blue bars show the historic profits using the scale on the left-hand axis; the purple line is the cumulative number to date with values shown on the right-hand axis; the other lines show the projected loss to the Treasury under various scenarios.
