Treasury receives £35bn in 'money for nothing' from Bank of England as it surrenders interest earned on QE assets

The Treasury will receive a £35billion windfall from the Bank of England, it was announced today, in an unexpected boon to the Chancellor's budgetary headache.

Governor Mervyn King has agreed that the Bank will hand over interest it has earned on its holding of £375billion in Government debt purchased under the quantitative easing programme.

The extra cash will constitute a bonus reduction to the budget deficit, while also acting as a 'small loosening of monetary conditions' equivalent to more QE, according to the Bank.



Easy money: Effectively, the Treasury is getting a quick boost to help fight the deficit

When the Bank announces a new tranche of QE, it essentially prints the money in return for Government bonds (or gilts). So far £375billion of QE has been pumped into the economy, so the Bank owns that amount of Government bonds, which it then earns interest on.

As of March, it had earned £24billion in interest payments, which will rise by a further £11billon by next March.



This will be returned to the Treasury, making a significant reduction to Government borrowing needs.



The Bank, which on Thursday decided not to extend its asset purchase scheme beyond the £375billion, said that the decision amounted to a slight loosening of monetary policy.

Gilt prices rallied on the news.



'Effectively that is £35billion of QE that we didn't know about half an hour ago,' said Citi strategist Jamie Searle. 'That is a bullish outcome for the gilt market. Gilts are rallying quite strongly and now we are seeing a very very good outperformance versus Bunds [German Government bonds].'



Mervyn King: Briefed the monetary policy committee on the agreement yesterday

The QE programme pays interest of 0.5 per cent on the money it uses to buy the gilts - but the Government pays it a higher interest on those gilts.

The Bank therefore slowly racks up earnings in interest. This is called 'surplus cash' by Chancellor George Osborne, and is stashed in something called the Asset Purchase Facility (APF) at Threadneedle Street.



That surplus cash will now amount to £35billion by next March and the authorities have decided that the best way to use it, is to reduce the budget deficit at the same time as injecting an extra monetary stimulus into the UK economy.

Opponents of QE - who think that it keeps inflation high and hammers pensions - will argue that this is QE by the back door.



'Holding large amounts of cash in the APF is economically inefficient as it requires the government to borrow money to fund these coupon payments,' said the Treasury upon announcing the agreement.



The Treasury said the agreement was in line with similar practices surrounding QE in the United States and Japan.



In a letter to Mr Osborne, Sir Mervyn stressed that the cash transferred to the Government would likely need to be paid back to the Bank in the future.

'During its meeting of 7-8 November I briefed the monetary policy committee on the agreement we have reached,' the Sir Mervyn said.



'The committee was content that its ability to set the appropriate stance of monetary policy would not be affected by this action,' he added. 'But it noted that its policy setting would need to take account of the effect of this action, which amounts to a small loosening of monetary conditions.'

The move comes at an apt time for Mr Osborne as he faces pressure on his aims to cut borrowing.

