John Redwood: The Chancellor must stop the bank losses first, before wrangling with her other problems

Sir John Redwood is a former MP for Wokingham and a former Secretary of State for Wales.

For more than two years I have been urging the Bank of England to stop selling bonds into the market incurring  large losses.

The Bank, the government and the media ignored the advice and did not even acknowledge there was an issue. The OBR set out how the Bank would likely lose £257bn between 2022 and the final liquidation of its large bond portfolio. These unacceptable and unaffordable losses stayed hidden in plain sight as an unread item of no interest in  long OBR reports.

It is true Liam Halligan raised the matter and  GB News gave me a platform to talk about it but the rest stayed silent. Suddenly, on 29^th August the IPPR left of centre think tank caught up with the problem and the BBC at last saw it was after all an interesting topic.

    More people should have asked why is the Bank so determined to lose so much money by selling bombed out bonds, when they could hold the bonds until they mature, cutting the losses considerably? Why does the government put up with it, when they had to agree to the bond policy and worse still offered a full guarantee to repay the Bank for any losses? The reason the Bank is so relaxed about recording some of the biggest corporate losses ever is they will get it all back from the Treasury and hard pressed taxpayers. The fact that the Treasury is paying gives the Treasury every right to change the Bank’s policy. The magnitude of the likely losses seems to spook people into saying nothing. If the OBR are right the Bank could lose  two and a half times the excessive costs of HS2. It could lose us four years of the whole defence budget.

    Just stopping selling the bonds at big losses will not remove all the loss. The Bank will lose less on repayment of the bonds as most of the bonds were deliberately bought at prices higher than their repayment value to depress rates more. These losses will be smaller and more spread out. The Bank will also continue losing money on the gap between how much interest it gets from owning the bonds, and the amount it pays out to its depositors. The Bank, unlike the European Central Bank and all commercial banks, gives the same rate of interest to the depositors as it charges for lending. Now it has hiked this interest rate a lot the income on the bonds it bought at high prices and low interest rates  falls well short. The Bank might like to consider adopting more normal banking practice to reduce its running losses.

     This  is urgent and of vital importance to the nation’s finances. Selling bonds on a large scale at a loss when you do not need to drives down bond prices and pushes up the costs of government borrowing. It is not just the government’s high spending plans but also Bank conduct that has meant the 10 and  30 year interest rate has been above the 2022 peak all this year. The Bank claims its sales do not depress prices, yet it undertook purchases deliberately to boost prices.

As the Bank is owned by the state it means two branches of the state are fighting each other. The Treasury has an interest in keeping the cost of longer term borrowing down, and the Bank delights in helping push it up. Of course if the Bank thinks there is a need to push up longer term interest rates to get inflation down, then it has the right and the need to say so and do so . In this case the Bank denies there is a monetary policy purpose to its sale of bonds and usually fails to mention it in its Inflation reports, or just makes  a passing neutral reference.

    So why is the Bank doing it? The nearest it has come to an explanation implies it would like to contract its own balance sheet for now, in case it needed to expand it again sometime in the future. This is a strange argument as there is no theoretical limit to the size of the Bank balance sheet given its special powers to create money and buy bonds. There is a judgement to be made before doing that to make sure it will not be inflationary.  Wishing to limit inflation should in future limit the extent of any Quantitative easing or money creation for bond purchase.

      Much of the press and media are full of stories about UK government debt becoming unaffordable. They are right that the government in the last budget increased spending by too much and took the deficit dangerously high. The government could help itself immediately by stopping the Bank’s selling programme helping force up rates more, and by cutting the costs to the taxpayer of the losses.

When a sailing ship is in a gale you should start by taking in the easiest sails first, before getting to grips with the rest. The government could do that on public spending by tackling excessive Bank losses and interest rate costs.