Has Treasury magically cut debt by £35bn?

Sterling notes

Here is my take on the slightly befuddling deal today between the Bank of England and the Treasury, which will see the Treasury remove supposedly surplus cash from the Bank of England's Asset Purchase Facility (APF).

The first thing to know is that the APF borrows from the Bank of England at 0.5% to purchase debt or gilts issued by the government in the famous quantitative-easing policy.

Or to put it another way, the APF has borrowed £375bn at 0.5% to effectively lend £375bn to the Treasury.

Now the Treasury pays a rather higher interest rate or coupon on that £375bn to the APF (although the Treasury can't tell me what the implicit interest rate on that £375bn is, because it is made up of lots of different loans with different maturities and different coupons).

So the APF has been making a cash profit on the difference between the interest rate it pays to the Bank of England and the interest rate it received from the Treasury.

And as of the end of March this year, that profit - called "surplus cash" by the chancellor - was £24bn. And the surplus is expected to increase by another £11bn this year.

George Osborne has decided that it is bonkers for the Treasury to borrow £11bn a year to generate spare cash that sits at the APF doing nothing.

So he has reached agreement with Sir Mervyn King, the Governor of the Bank of England, that the surplus or spare cash will be returned to the Treasury - although not all the surplus cash will come back in a single lump.

This year, the £11bn of surplus cash will not be handed to the APF. Which will mean that the government's huge debt will fall by £11bn - and the government's deficit will also fall by £11bn, if the Office for National Statistics agrees that this represents a genuine reduction in the borrowing requirement.

Next year, 2013-14, the remaining £24bn will be handed to the Treasury.

Thereafter, the Treasury will in effect pay just 0.5% interest on whatever stock of its debt is still held by the APF (if you have lost the will to live by this stage, I don't really blame you).

What does it all mean?

Well in simple terms, it means that the cost today for the government of borrowing the £375bn of debt held by the Bank of England is falling by around 3 percentage points, or roughly £11bn a year - which is a substantial saving.

But - and this is important - what we are fundamentally looking at here is a timing benefit, rather than something more fundamental. Because all that surplus cash would have been returned to the Treasury at the point that quantitative easing came to an end and the APF was wound up.

We are talking about a useful acceleration of cash flow.

That said, there may be real incremental savings to the government, if the reduction in its perceived stock of debt allows it to borrow at marginally lower interest rates. However that incremental saving is incredibly difficult to quantify.

Which is not to argue that the perception of the quantum of debt is irrelevant. One of the reasons the chancellor has made this reform is that he believes it brings the UK into line with practice in Japan and the US - whose deficits, Mr Osborne would argue, have been deflated by the fact that they don't allow their central banks to accumulate surplus cash.

What is vital to recognise is that this change should make it neither easier or harder for the Treasury to hit its target that by 2015/16 the national debt will be falling as a perecentage of GDP - because there will be a one-off reduction to the national debt in the previous year, which will have no impact on the trend between 2014/15 and 2015/16 (stay with me).

Those economists currently warning that the government will miss this important target are unlikely to change their view.

Or to put it another way, this is an immensely complicated renegotiation of a contract between the Bank of England and the Treasury whose real economic impact is fairly trivial.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 149.

    Not if the bank notes are marked - "To be paid by my children".

  • rate this

    Comment number 148.

    146 Emkay,

    I agree entirely with you, but the UK runs a large deficit with the EZ yet the GBP has got stronger against the euro.

    Perhaps we can go printing money to infinity?

  • rate this

    Comment number 147.

    27 July 2012 - Mr Blake has been appointed "Chief Risk Officer" at the State-owned IBRC (Irish Bank Resolution Corporation Limited - an asset recovery bank - formerly Anglo Irish Bank and Irish Nationwide Building Society.)

    Irish Dept of Finance sanctioned a package of over 500,000 euros.

    They still do not get it...

  • rate this

    Comment number 146.

    Charles Jurcich:- I am afraid your statement isnt entirely true. One effect of printing more money is that the exchange rate of your currency weakens (there is more money therefore each unit is worth less.

    The effect of this is that all the goods which are imported (for us this is almost all raw materials) become more expensive. Hence inflation.

  • rate this

    Comment number 145.

    144 PW
    The terminology comes originally from the gold standard era, and later Monetarism which effectively treated fiat currency as if we still had a gold standard.

    With fiat money printing doesn't cause inflation - spending too much can, but only when the economy is already at full capacity.

  • rate this

    Comment number 144.

    Charles Jurcich

    'Govt debt is never a problem where a govt issues its own currency'

    To be honest you seem to be more familiar with these financial matters than me but surely it isn't that simple. We need to borrow to finance our debt (is it still called the PSBR?). If we simply print our way out of debt (QE) won;t that cause high inflation and therefore a currency devaluation?

  • rate this

    Comment number 143.

    142 PW
    "Isn't the whole problem with western economies a case of too much debt and that they need to live within their means?"

    No, the problem was over-leveraged banks and excessive private sector debt. Govt debt is never a problem where a govt issues its own currency - it can never become insolvent in its own currency. The inner working of QE above show how govt can always pay its debts.

  • rate this

    Comment number 142.

    Charles Jurcich

    Why is it needless to reduce government debt? Isn't the whole problem with western economies a case of too much debt and that they need to live within their means? Also RP seems to say that it doesn't actually make any difference to the deficit so splurging it on new projects is not going to help.

  • rate this

    Comment number 141.

    "...there may be real incremental savings to the government, if the reduction in its perceived stock of debt allows it to borrow at marginally lower interest rates."

    Only if you fall for the idea that the bond markets think there is too much govt debt. This was always a fallacy. The truth is they can't get enough govt debt especially while there is little risk-free yield anywhere else.

  • rate this

    Comment number 140.

    I've been talking about this for over 2 years now, and everyone thought I was mad. Now all the govt has to learn is that it would be better to spend this money on new housing stock rather than needlessly reducing govt debt.

  • rate this

    Comment number 139.

    let's set the record straight here.
    this is smoke and mirrors.
    the government borrows the money via its fiscal deficit, thereby borrowing money. this is an increase in money supplied to the economy.
    the bank of england has bought 375 billion of government debt, accumulated from past fiscal deficits.
    the bank of england is a government department. this is an intergovernment transfer.
    govt fraud

  • rate this

    Comment number 138.

    But what if QE is never (fully) reversed?

    The large quantity of gilts held by the BoE could be "rolled over" - if necessary with new money - and the money supply be left permanently increased. If inflation increases too much then the BoE can just raise interest rates.

    Or am I missing something?

  • rate this

    Comment number 137.

    Remind me again, when is the election due?

  • rate this

    Comment number 136.

    #134. Sage Against The Machine
    "Why therefore do we allow private banks to continue creating money out nothing"

    Because that defines the system we are in.
    Banking defines us.
    That is why we suffer them.

    And boy oh boy do they know it.
    It allows them to fill their boots at a moments notice.
    Safe in the knowledge that they can do no wrong.

    Only another Bretton Woods gathering could sort it out..

  • rate this

    Comment number 135.

    I always thought that 'Pasty George' was more suited to magic than economic competence.
    The total amount should be given to taxpayers. They would spend it, increase demand for goods and services, stimulate growth, reduce unemployment and welfare payments.
    With George, the undertaker, an avowed neoliberal child of the 'Grantham Spam Hoarder' it is not likely to happen.

  • rate this

    Comment number 134.

    Yes, an immensely complex deal to hide the fact that the entire money system is a scam. Please stop referring to all this as cash, Robert. It's digital money. Records of credit. So now we know that the Treasury can effectively print its own money (sell national debt at 3% buy money at 0.5%). Why therefore do we allow private banks to continue creating money out nothing for a lot more than that?

  • rate this

    Comment number 133.

    Does this mean that officials, whether from the BoE or the Treasury, have been sat on a pile of cash ever since QE began?

    Presumably this money has either been earning interest for somebody or not.

    Either way those officials got it wrong.
    Otherwise Gideon has got it wrong.

    Somebody should pay.

    All in all it all just goes to show what a shambles central banking is.

    And how false economies are.

  • rate this

    Comment number 132.

    So we need not have bothered with austerity which shrank GDP, reduced tax revenue, inflated welfare costs & expanded borrowing by £150 Bn when we could have monetised £350 Bn of debt, as the BoE & Treasury have just effectively done two years ago = smokescreen for "Smash the State"

    But printing money to fund government is the route to the Weimar Republic hyperinflation, as Mugabe found out.

  • rate this

    Comment number 131.

    "Typical accountants cooking the books once again, so in reality we have never been ??? in debt because we £35 billion hidden away "

    No - because this is interest earned over the period of QE - and no agin because the nation owes nearer to a £Trillion.

    After all this time, how can anyone still not understand the dire state our debts have caused to the economy.

  • rate this

    Comment number 130.

    This is surely more than just a timing benefit. The BoE has 'printed' money under QE to buy the bonds. When the bonds get re-sold and QE unwound, this new money will be cancelled but the 3% interest saving to UK Govt will make a permanent net contribution of £35bn to the Treasury as the benefit of having temporarily printed this money.


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