Tears, tightening, and the treasury: can Bailey help Reeves regain control
As Chancellor, Rachel Reeves faces a daunting balancing act: proving Labour’s fiscal credibility while managing the party’s expectations for increased public spending. It’s a political and economic tightrope - but the Bank of England could play a role in helping her to maintain control.
The Bank still holds a substantial portfolio of UK government bonds (Gilts), acquired between 2009 and 2021 under the Quantitative Easing (QE) programme. QE was designed to lower borrowing costs and support the economy after the 2008 global financial crisis and the COVID-19 pandemic. While its effectiveness remains debated, the Bank maintains it played a key role in stabilizing the UK economy during turbulent times.
However, there’s a catch. The Bank bought most of these Gilts when yields were low and prices were high. As a result, it now sits on an estimated unrealised loss of £162 billion, or about 5.7% of UK GDP. That’s a staggering figure, and unfortunately, UK taxpayers are on the hook for much of it. While some of these losses are already baked into government debt forecasts, roughly half are not.
So, how can the Bank of England help?
Currently, the Bank is unwinding its QE holdings through Quantitative Tightening (QT), selling off Gilts to shrink its balance sheet. The pace is around £100 billion per year - half through maturing bonds, half through active sales. But with the average holding showing a 23% loss to book value (and 11% to par), these sales are crystallising losses and adding to the national debt.
Out of 45 Gilt holdings, only three would generate a profit if sold today.
This raises a critical question: is now really the right time for aggressive QT? With the UK economy barely growing, a more cautious approach could be warranted. There’s speculation that the Bank may soon revise its QT target downward. If it does, the Office for Budget Responsibility (OBR) would likely lower its debt forecasts - offering Reeves some much-needed fiscal headroom.
A slower pace of QT could possibly ease Gilt yields, reducing the projected interest burden on national debt. That would be a welcome development for a Chancellor trying to prove her economic mettle while navigating a fragile recovery.
If Reeves can weather this period, she may emerge with a reputation for sound financial stewardship - just as other major economies struggle to get their fiscal houses in order. That alone might be enough to put a smile on her face.
