The Bank of England is accruing too much political interest

The writer is an FT contributing editor

When choices made a decade ago stir up a political storm you know you’re in a bad place.

For close to ten years the Bank of England sent quarterly payments to the Treasury — fiscal dividends of quantitative easing. Cumulatively these amounted to almost £125bn. Few hackles were raised. But since October 2022 the flow has reversed. Last year the Treasury sent the BoE £44bn to cover both the financing gap on its QE portfolio and losses realised on its bond sales. This was more than the UK government spent on long-term care. The BoE estimates that the QE programme’s lifetime draw on public sector accounts is likely to eclipse £100bn.

Moreover, there is now a direct line between the BoE Monetary Policy Committee’s decision on the pace of balance sheet reduction — so-called quantitative tightening, or QT — and the chancellor’s ability to tax and spend. According to analysis from the BoE, halting active bond sales would gift the chancellor up to £10bn a year of fiscal headroom. Having the MPC decisions define fiscal space so directly cannot be right. With steep losses and MPC decisions informing fiscal headroom, it’s unsurprising that several Conservative MPs have been angrily calling for the BoE’s independence to be reviewed.

The BoE and Office for Budget Responsibility have rightly argued that the fiscal implications of QE and QT cannot be captured by a bean-count of cash flows. The BoE maintains that the economy would be smaller in a world without QE. But bank officials’ performative indifference to QT’s drain on public accounts has not helped to defuse tensions. Bank officials are civil servants, whose remit speaks to delivering price and financial stability, not trading profits. Indifference to QT losses looks crafted to shore up market confidence in BoE independence. But it risks undermining that independence as cross-party support wanes.

If the political heat fuelling attacks on BoE independence stem from the impact on public accounts, it’s worth remembering that things don’t need to be this way. First, changing the pace at which the BoE winds down its balance sheet won’t change the magnitude of total lifetime cash costs much. It will just front or back load them. That the BoE’s choice around timing its balance sheet operations has any impact on the calculation of Britain’s fiscal rules shows how bad these rules are. Second, the UK’s choice in dealing with QE losses are not the international norm. Until 2012, coupons from bonds purchased by the BoE gathered dust in Threadneedle Street. George Osborne rightly changed practice to follow the Federal Reserve in sweeping QE profits to the Treasury. But he chose not to follow its standards for dealing with central bank losses, committing the Treasury to reverse the flows of cash if interest rates normalised or the BoE incurred losses on bonds purchased.

The Federal Reserve, whose QE book losses dwarf those of the BoE, makes no cash calls on Congress. This is despite distributing profits when times are good. Instead, losses create a deferred asset that can be repaid through the profits of seigniorage. Until extinguished, the Federal Reserve system essentially operates in negative equity.

America is far from alone in this approach. A Bank for International Settlements report found that out of 32 emerging market or small open economy central banks examined between 2001 and 2022, ten had run negative equity positions over the period. Furthermore, the report judged that neither financial nor price stability were troubled by this practice. A recent Bank of England working paper catalogued practice for 70 central banks around the world. They found that while the UK’s approach was not unique, it was part of a tiny minority of countries in taking such a hair-shirted approach to central bank losses.

One way forward would be for the UK to switch to US practice. True, this would risk an aura of perfidiousness. But doing so may be the lesser of two evils. Indeed, the IMF recommends re-examining the treatment of QE/QT profits and losses.

The current framework delivers results that are politically corrosive, which undermine central bank independence. Furthermore, it can’t be right that the chancellor’s headroom under fiscal rules should be swung by the timing at which losses are crystallised by the BoE. The coming general election is likely to divert heat from the BoE. But having identified the source of the problem, the best thing the next government can do is fix it.