The ‘Os-bourne’ Legacy

The issue of Quantitative Easing (“QE”) and the implications to the UK taxpayer is a topic we wrote about last year. While the intricacies of QE may induce glazed expressions in many, the staggering scale of its fiscal impact demands attention. George Osborne's recent defence of QE, disavowing responsibility, serves as a catalyst for revisiting these figures once more.

The Bank of England’s Asset Purchase Facility (QE) started in March 2009, during the Global Financial Crisis. Alistair Darling was the incumbent Chancellor at the time, but George Osborne oversaw the bulk of the early Gilt purchases during his tenure from 2010 to 2016. QE was only supposed to be a temporary policy tool to help the UK economy recover from the effects of the Financial Crisis but it became a more permanent policy tool and was used extensively following the COVID pandemic by Rishi Sunak. The negative consequences of that are now becoming clear.

A total of £1.1 trillion has been invested in the Gilt market by the Bank of England, almost half of that investment occurred on Sunak’s watch.

This chart includes the purchases which were reinvestments of maturing Gilts

George Osborne was quoted in a recent article as saying ”It was a necessary policy to get us out of the financial crash and contributed to the fastest recovery of any G7 economy. It was all part of a plan that convinced the world Britain had got its act together. The Treasury and Parliament at the time assessed all the eventualities. Of course there were gains for the Exchequer back then. I can’t speak for the current situation – that’s not my responsibility anymore”.

Those gains for the Exchequer were substantial. Osborne arranged for the coupons received by the Bank to be transferred to the Treasury. In return, the Bank’s funding of Gilt purchases were paid by the Treasury and any losses borne by the Bank would be covered by the taxpayer. When interest rates were anchored at 0.5% and the average coupon on Gilts was around 2.5%, this generated a significant income surplus for the Treasury, reaching a cumulative total of over £120bn by the end of 2022. But as we know, funding rates have soared, Gilt coupons are fixed and Gilt prices have collapsed, which changes the picture dramatically. I think it’s clear that no one in Parliament appreciated the long-term consequences of Osborne’s arrangement with the Bank.

To be fair to Osborne, the Gilt purchases during his tenure as Chancellor generated a profit (including coupons) of just over £90bn and just over half of those Gilts have already matured.

The real financial damage has been caused by the huge purchases of Gilts during the COVID pandemic. The average yield to maturity of Gilts bought during Sunak’s tenure as Chancellor was 0.49%, compared to 4.32% today (10yr benchmark Gilt). We were not alone in questioning the wisdom of that splurge of what was effectively public money.

The Bank of England is now reducing its Gilt portfolio (via Quantitative Tightening) as part of its effort to reduce inflation. The pace of sales is currently at £100bn per year. The problem is that there are no profits available in the Bank’s portfolio of 49 Gilt holdings. Consequently, some MPs are asking why the Bank is continuing to crystallise losses, which have to be funded by the taxpayer.

By our calculations, the Bank’s portfolio is worth £517bn, compared to a book value of £701bn. That’s an unrealised loss of £183bn, to which we need to add losses from matured Gilts of £31.1bn and sold Gilts of £32.4bn. That brings us to a total (and catastrophic) loss of £247bn – approximately 9% of the UK economy.

The OBR predicts a crystallised loss of £100bn by 2032, but that would assume there are no further losses crystallised via the QT process. Does the OBR know something about Labour party policy? Is Rachel Reeves going to boost her finances by instructing the Bank to stop QT? With Trump rumoured to be drafting plans to control US interest rates during his Presidency, perhaps this is not too far-fetched? But any weakening of the independence of Central Banks will not be taken well by financial markets.

The bottom line for Jeremy Hunt is that he has had to fund losses from Gilt sales of £19bn during the last financial year. He also had to fund the difference between the Bank’s funding and the income from Gilt coupons – another £16bn during the last tax year.

QE is costing the Chancellor £35bn per year (about 1.3% of UK GDP) at a time when he could have used that extra firepower to help the economy and improve the Tory’s chances of re-election. But like Osborne, that won’t be his responsibility anymore, quite soon.