The Asset Purchase Facility is in profit by an estimated £30 billion on the £200 billion of securities, mostly gilts, bought in 2009-10. The authorities could book an immediate fiscal gain by closing down the Facility, cancelling its gilt holdings and transferring responsibility for its Bank of England loan to the Treasury. This would cut public sector net borrowing by £19 billion this year and up to £8 billion in future years.
The Asset Purchase Facility bought a net £200.0 billion of securities over 2009-10, of which £198.3 billion were gilts. According to its latest annual report, the Facility was in profit by £9.8 billion on 28 February 2011 (the profit is recorded in the accounts as a liability to the Treasury). The profit on that date comprised net interest receipts of an estimated £11.5 billion offset by a capital loss of £1.7 billion. The Facility enjoys a net interest surplus because the running yield on the securities portfolio is about 4.5% while it pays Bank rate, currently 0.5%, on its £199.9 billion loan from the Bank of England. The Facility’s profit is currently excluded from the targeted public sector net borrowing measure but will be included on its closure, following the sale of securities.
The scheme’s profit has ballooned since February as gilt yields have fallen sharply – the 10-year yield has declined from 3.69% on 28 February to 2.72% yesterday, according to Thomson Reuters Datastream. A back of the envelope calculation suggests that the profit is now about £30 billion, comprising net interest receipts of £15 billion and a capital gain on securities of £15 billion.
The net interest surplus is permanent but the capital gain will disappear if gilt yields reverse their recent fall. Indeed, by the time the Bank chooses to sell the gilts, yields may have risen sufficiently to push the scheme into loss, despite a rising interest surplus.
To avoid this risk, the proposal is that the authorities should crystallise an immediate gain by closing down the Facility in the following way:
1. The Treasury / Debt Management Office cancels the gilts held by the Facility.
2. In return, the Treasury takes over the Facility’s loan from the Bank.
3. The Facility’s cash holdings – reflecting its net interest income – are transferred to the Treasury.
This would benefit the fiscal accounts in two ways. First, the one-off transfer of the Facility’s cash would reduce public sector net borrowing by £15 billion in 2011-12. Secondly, the replacement of higher-yielding gilts with a low-interest loan from the Bank of England would cut the debt interest bill by an estimated £4 billion in 2011-12 (if closure is effected by the end of September) and by £8 billion in future years, assuming an unchanged level of Bank rate.
So public sector net borrowing would be reduced by an estimated £19 billion, or 1.2% of GDP, in 2011-12 and by £8 billion in future years, for as long as the Bank of England maintains Bank rate at 0.5%.
Possible objections to this proposal include:
The Bank should retain the gilts in order to sell them back to the market at a future date when credit and broad money are growing strongly, warranting a reversal of the 2009-10 monetary injection.This “problem” is unlikely to emerge any time soon, given official pressure for bank deleveraging. The Bank’s Financial Policy Committee, moreover, can employ new tools to restrain credit and monetary expansion, such as cyclical capital requirements and limits on loan to value ratios.
The Bank needs to be able to sell the gilts at a future date to reduce the high level of cash held by banks in their accounts at the central bank. The banks’ free cash reserves at the Bank can be reduced in other ways, such as increasing reserve requirements, auctioning term deposits or selling short-term Bank of England bills.
The average maturity of the national debt is reduced by the Treasury swapping longer-term gilt liabilities for a loan linked to Bank rate. True, but the average maturity of debt held by the market is unchanged by the transaction.
The swap means that future debt interest costs could be higher if the Bank of England were forced to jack up Bank rate sharply.True, but Bank rate would need to average more than 4.5% over the life of the cancelled gilts for the cumulative bill to be higher.
Closing the Asset Purchase Facility precludes the Bank from engaging in more QE. Wrong. The proposal is to close and book profit on “APF1”. The Bank / Treasury could set up “APF2” to conduct any new operations.