U.K. Reaps $13 Billion of Interest From Own Debt in QE Quirk

The U.K. Treasury is getting almost 10 billion pounds ($13 billion) a year in interest on its own debt under the Bank of England’s bond-buying plan.

That’s the curious result of a massive increase in bond issuance to fight the pandemic crisis, combined with the dramatic reduction in BOE interest rates. The government is currently earning about 1.4% annually from more than 700 billion pounds of gilts that are held by the BOE, according to calculations by UBS strategist John Wraith.

The sum covers about a quarter of the cost of the government’s job-support program so far. It’s a nice benefit for Chancellor of the Exchequer Rishi Sunak, beyond the direct impact of the BOE’s measures in keeping the cost of financing the virus response low and stable.

The income is a by-product of the way the BOE’s asset-purchase program is structured. The reserves it creates to fund its buying are financed at the bank’s main interest rate, while it receives the coupon payments on the securities. The resulting profit is handed over to the Treasury.

The bonus has been super-charged this year as central bank officials slashed interest rates to 0.1%.

With the bonds yielding 1.5%, UBS calculates the holdings are accruing interest of around 9.94 billion pounds annually. That figure will stay around the same level for “at least the next couple of years,” Wraith wrote in a report.

Not So Mature

Still, the good news comes with a catch, as a significant hike in rates by the BOE could reverse the benefit.

Sunak has cited the risks of higher borrowing costs as a reason to curb government spending, and on Wednesday he said he needs to “keep an eye” on the debt pile because a rise in interest rates would be “problematic.”

But economists and investors say it will be years before that happens, and BOE policy maker Michael Saunders said Friday that there’s room to take rates even lower.

A more tangible problem is that financing long-term debt at bank rate also reduces the average maturity of U.K. gilts from 16 years to 10 years, according to UBS.

That undercuts the U.K.’s historic benefit of having one of the longest-maturity debt profiles in the world, a fact that has been highlighted by ratings companies as offering them greater protection against interest-rate and refinancing risk.

©2020 Bloomberg L.P.

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