The Bank of England's costly exit from QE

The Bank of England is set this week to slow its getaway. Alongside its interest-rate verdict, it is expected to announce an overhaul of quantitative tightening (QT) — the winding down of the £800bn-plus of government bonds it bought during the financial crisis and the pandemic. According to reports, the plan is to stop selling its longest-dated gilts, the 20- and 30-year bonds whose prices have fallen furthest, and to trim the annual pace of sales again, from £70bn to £50bn. It is tempting to file this as technical plumbing. It is not. The episode is a live case study in how an institution that prides itself on independence ends up bending its own balance-sheet policy to the fiscal and market pressure its choices have created.

Why unwinding became expensive

The mechanics carry the point. Between 2009 and 2021 the Bank bought roughly £875bn of gilts, financed not with printing money in the old sense but with reserves on which it now pays interest at Bank Rate. Quantitative easing looked free while rates were near zero and bond prices rose. The reverse is true of its unwinding. When the Bank sells a bond it bought when yields were low and must now place at yields above 5%, the loss is crystallised; and while it holds out-dated paper, it pays more to banks on reserves than those bonds earn. Both forces drain the Asset Purchase Facility, and through it the exchequer.

The other channel runs through the gilt market itself. By selling bonds back to the private sector, QT returns duration to investors, adding supply that pushes up longer-term yields precisely when the government most needs to borrow cheaply. British 10-year yields have passed 5.4%, the highest since July 2007; the 30-year has touched 5.93%, a level last seen in March 1998. The portfolio has already been cut from its peak of about £875bn to just under £490bn — one of the fastest reductions among large economies.

Complainants put a price on all this. The Bank itself estimated in August that its QT stance could deliver £120bn of losses to the exchequer over time, on market-implied rate paths; the Office for Budget Responsibility reckons active sales will add roughly £47bn to government debt by 2031. Others note that the European Central Bank has nudged its losses against the same tide at a lower cost, because it holds long-dated purchases to maturity rather than selling into a falling market.

The contested statement

The governor, Andrew Bailey, rejects the accounting. Sales, he argues, alter the timing of cashflows but not their total, making selling and holding "broadly neutral" once the benefit of having locked in long-term borrowing at low rates is counted; seigniorage on banknotes adds around £3.4bn a year on top. He has called the notion of slowing QT to shield the Treasury from losses a "misconception".

The ledger, however, is hard to make flattering. The Bank transferred nearly £124bn to the government between 2013 and 2022; the government has transferred roughly £108bn back to the Bank since late 2022. On either telling, the cushion built during the cheap-money years has been spent, and then some. Whatever one thinks of Bailey's claim that holding to maturity would not improve the outcome, it takes a certain confidence to call a policy costless in the same week its pace is being halved and its long end abandoned. The Federal Reserve, it is worth recalling, stopped actively selling its portfolio last year; the Bank, which had presented itself as ahead of the curve, is now following belatedly into a stressed market.

The deeper point is institutional. Critics say the "firewall" between the Bank and the Treasury is a fiction — that a balance-sheet unwind landing billions on the fiscus cannot remain insulated from politics while a chancellor prepares a budget and bond markets wobble. On this reading, today's retreat is not a one-off tweak but the visible edge of fiscal dominance: the terms on which the Bank shrinks its balance sheet are now set as much by the government's borrowing costs as by its own inflation target. The Bank would deny it, with reason — the capacity to act again in a future crisis is worth preserving. But the direction of travel is plain enough.

What an investor should read into it

For the retail investor, the interest is not in buying or selling gilts. It is in what a stressed public funding market signals. Long-dated yields near 25-year highs are a barometer of fiscal credibility; a central bank retreating from the long end is evidence of stress in the funding market, not of its disappearance. That tension — an inflation-fighter easing its grip on supply while inflation still runs ahead of target (around 3.1% against a 2% goal) — is precisely the sort of condition under which the risk premium demanded of long government debt stays elevated, nudging up borrowing costs everywhere yields spill.

There is a transferable lesson too. QE's profits were paper profits, contingent on a regime of near-zero rates. When rates normalise, unwinding those positions converts the paper into real losses that land on taxpayers every bit as surely as a tax rise would, whatever euphemism a central bank chooses. The long end of the gilt curve, not the headline rate decision, is where this story will be decided.