Recent data reveals that the UK Treasury will allocate ÂŁ130bn over the next five years to cover the Bank of England’s mounting losses. This staggering sum could instead be used to fund the construction of over half a million new social homes.
Amid rumors that the government plans to slash £3bn from disability payments, it’s perplexing to see the Treasury commit £26bn annually to the Bank of England without significant public debate. This raises an important question: Why does a central bank, capable of creating money, need such substantial transfers? And how does this align with the concept of central bank independence?
While the answer is complex, the implications are clear. These costs represent massive public sector funds funneled into the financial sector, limiting the Chancellor’s ability to meet fiscal targets. To counteract austerity and invest in essential public infrastructure, a fundamental shift in approach is needed. Encouragingly, international examples suggest that better management of central bank balance sheets could unlock over £130bn by 2030—enough to build more than half a million new social homes.
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Why Are Central Banks Losing Money?
Globally, central banks are grappling with financial losses as their expenses outpace income. This is primarily due to the aftermath of quantitative easing (QE), a policy where central banks purchased government bonds at low interest rates to stimulate the economy. These bonds were bought using newly created reserves—the digital money held by private banks and used in monetary policy. However, as central bank interest rates have risen above the returns on these bonds, central banks now face substantial losses.
In the UK, these losses have been exacerbated by quantitative tightening (QT), where the Bank of England has sold bonds back to the market rather than letting them mature. With rising interest rates, bond prices have plummeted, causing further financial strain. Recent sales have seen bonds sold for as little as 28% of their original value, amplifying the losses.
The Impact on Public Finances
In the UK, an indemnity agreement between the Treasury and the Bank of England means these losses directly impact tax revenue and borrowing levels. This agreement, initially made by George Osborne in 2012 when QE was profitable, allowed the Treasury to receive nearly ÂŁ125bn from the Bank of England between 2012 and 2022. However, this financial benefit has essentially been reversed in the last two years, with the Treasury now absorbing over ÂŁ70bn in losses. According to the latest data from the Bank of England, by 2027, the Treasury is expected to face substantial losses from this arrangement, potentially surpassing ÂŁ150bn by the early 2030s.
Reforming the System: A Path Forward
These losses aren’t inevitable. By implementing reforms such as tiering reserves, slowing QT, and adjusting the indemnity agreement, the financial burden on the Treasury could be alleviated. Such reforms have already been successfully introduced in other countries, offering a potential solution to the UK’s current economic challenges. Through these changes, the government could free up significant resources—resources that could be invested in vital public services and infrastructure, including building the much-needed social housing that the country desperately requires.
Reversing Austerity and Investing in Public Infrastructure: A Call for Change
Tiered reserves could significantly reduce the interest the central bank pays to private banks. This system requires banks to hold a portion of their reserves that earn no interest, while higher reserves above the “reserve requirement” tier still earn interest. This approach ensures that the central bank can effectively transmit its interest rate policy while reducing unnecessary costs. The European Central Bank (ECB) implemented this system in 2023, saving €5bn annually. According to the New Economics Foundation (NEF), the UK could save ÂŁ1.3bn each year if it adopted the same model. Moreover, higher reserve requirements—used internationally and historically—could save up to ÂŁ11.3bn annually.
While some express concern that this could reduce bank revenues and tighten monetary conditions, potentially leading banks to pass on costs to borrowers, this issue could be mitigated with lower interest rates and a more cautious approach. Additionally, while a tax on bank profits could help recoup some of the windfall banks have already received, tiering reserves offer an initial safeguard to prevent bank profitability from being overly reliant on central bank transfers.
Slowing Quantitative Tightening: A Solution to Losses
Another key contributor to the Bank of England’s mounting losses is its active quantitative tightening (QT) sales. NEF estimates that slowing down the pace of these sales to the levels seen in 2022–2023 could save ÂŁ4.4bn annually, while halting active sales entirely could save up to ÂŁ13.5bn per year. This approach would bring the UK in line with the eurozone and the US, where active sales are generally avoided.
The Bank justifies its rapid QT pace by citing the interest rate losses from holding long-term bonds. However, these losses are a direct result of the Bank’s decision to raise interest rates. By slowing down sales and exploring other options to reduce interest rate risk—such as tiering reserves and reassessing its interest rate strategy—the Bank could achieve more effective solutions while reducing the financial burden on the Treasury.
Protecting the Bank’s Independence Requires Reducing the Treasury’s Burden
Instead of relying on an indemnity, the UK could shift to a deferred asset system similar to those used by the US Federal Reserve and the European Central Bank (ECB). Under this model, central bank losses are recorded as assets on the balance sheet to be repaid through future profits. While primarily an accounting adjustment, this method avoids placing immediate strain on taxation and borrowing. As Chris Giles of the Financial Times points out, “monetary financing would look the same on central banks’ balance sheets,” but the deferred asset ensures any impact remains temporary.
Transitioning to a deferred asset system could free up to £26bn per year for the Treasury. Although these savings would eventually offset future profits, historical patterns suggest that annual profits are much smaller than the scale of potential losses, allowing the costs to be smoothed over time. Notably, a deferred asset is just one option; financial arrangements between treasuries and central banks are often updated and restructured. With the Bank’s current strain on fiscal rules, now is the right time to rethink how these costs are managed.
While fiscal rules themselves are often to blame for creating artificial limits on public spending, the additional pressure from the Bank is clearly making the situation worse. As the Federal Reserve notes, its losses “do not affect [its] ability to conduct monetary policy or meet its financial obligations.” This raises a crucial question: why can’t the Bank of England absorb more of these costs itself?
Reforming the system would protect the Bank’s independence, unlock billions in public spending, help avoid unnecessary austerity, and contribute to building a fairer, more resilient monetary framework.
Frequently Asked Question
How is the Bank of England costing the UK billions?
The Bank of England’s losses from quantitative easing (QE) and rapid quantitative tightening (QT) require the Treasury to cover shortfalls, transferring billions in public funds to the Bank annually.
Why does the Treasury have to cover the Bank of England’s losses?
An indemnity agreement, created in 2012, obligates the Treasury to cover losses from QE operations. When the Bank’s income falls short, taxpayers foot the bill.
What role did quantitative easing (QE) play in creating these losses?
During QE, the Bank bought government bonds at low interest rates. As interest rates rose, the income from these bonds dropped below the cost of maintaining them, leading to significant financial losses.
How much is the Treasury expected to pay the Bank of England?
New figures show the Treasury will transfer around ÂŁ130 billion to the Bank over the next five years, significantly impacting public spending capacity.
Could these billions be used for something else?
Yes. The ÂŁ130 billion could fund the construction of over half a million social homes, dramatically easing the UK’s housing crisis.
Is there an alternative to the indemnity agreement?
Yes. Other central banks, such as the US Federal Reserve and ECB, use a deferred asset system that records losses to be offset by future profits, avoiding immediate pressure on public finances.
How could tiered reserves reduce these costs?
Tiered reserves, which require banks to hold non-interest-paying reserves, could slash the amount of interest the Bank of England pays to private banks, saving billions each year.
Conclusion
The Bank of England’s current financial practices are placing a massive and growing burden on the Treasury, costing taxpayers billions that could otherwise fund vital public services, infrastructure, and social programs. From losses linked to quantitative easing and tightening to outdated indemnity agreements, the system urgently needs reform.
International examples show better ways to manage central bank losses—through strategies like deferred assets, tiered reserves, and slower bond sales—that ease pressure without sacrificing monetary policy goals. Without change, the Bank risks not only weakening the UK’s fiscal health but also undermining its independence.