Rachel Reeves could save over £20bn on bond sales by scrapping agreement to cover Bank of England losses, says think tank

The Treasury could save over £20bn a year by abolishing the requirement to cover the Bank of England's losses, according to a report from the New Economics Foundation (NEF), published today.

The Bank of England currently costs the government more than the entire Home Office's budget each year, despite these costs receiving little political scrutiny. No longer covering Bank of England losses would reduce the need for chancellor Rachel Reeves to borrow via issuing bonds or raise broad-based taxes in the upcoming autumn budget.

Today's report finds that the Bank of England can absorb its own losses without becoming insolvent or causing financial instability. Other central banks like the United States Federal Reserve and the European Central Bank already absorb their own losses through accounting which allows them to retain their profits – which would otherwise be sent to the government – until their losses are paid off. Adopting a similar framework in the UK could save the Treasury from having to cover over £20bn a year with additional bond issuance.

The Treasury spends money to cover central bank losses due to the indemnity - a policy introduced by George Osborne in 2012, which required that the Treasury would benefit from any profits but also cover any costs incurred by the Bank of England. This was introduced to help Osborne meet his fiscal rules during a period when the Bank of England's quantitative easing operations were profitable. Today's report recommends that Rachel Reeves change this agreement, to avoid significantly raising broad-based taxes at the autumn budget.

According to its own figures, by 2033, the Bank of England is expected to have cost the Treasury £150bn. Today's report details how this loss for the UK's central bank represents a massive transfer of public money to the commercial banking sector. During quantitative easing, the Bank of England bought government bonds at very low interest rates to try to stimulate the economy. These bonds were bought with newly created reserves, which the Bank also pays interest on. As the Bank has raised interest rates, the interest it pays on reserves has outstripped the interest income received from government bonds, losing the Bank of England money and profiting the banks who received reserves.

In addition to scrapping the indemnity, the report recommends that the Bank of England no longer pay interest on a portion of reserves held by commercial banks.  This “tiered reserve” framework would reduce the Bank's transfer of billions to the banking sector while maintaining monetary policy transmission, ensuring the Bank is providing value for money in its policy operations. Following reserve requirements set by the European Central Bank or Swiss National Bank could save between £1.3bn and £5.3bn per year.

Dominic Caddick, economist at the New Economics Foundation (NEF), said:

“This year, the Bank of England has found itself under attack from all angles, with critics pointing to its eye-watering cost to the Treasury. Reducing its financial dependence on the government may be the Bank's best defence.

“With the autumn budget approaching, the high cost of government borrowing will be keeping Rachel Reeves up at night. The Bank's decision to slow its bond sales hasn't relieved the pressure on bond markets, but there is another change which could save the chancellor billions.

“Instead of billing the Treasury for its losses, the Bank of England could begin to absorb its losses itself. Abolishing the Osborne-era agreement for the Treasury to cover the Bank's losses would bring us in line with the US and Eurozone, without risks to the Bank's operations.”