The Chancellor, George Osborne has agreed with the Bank of England that gilt interest payments created by the quantitative easing (QE) programme will become Treasury receipts in a move that will help the government’s finances.
The Asset Purchase Facility (APF) borrows money from the Bank of England at a rate of 0.50 per cent to buy gilts issued by the government to fund the QE programme. The Treasury pays a higher, unspecified rate of interest on the money that it borrows.
This means that the APF has been making a profit on the difference between the interest rate it pays to the central bank and the interest it receives from the Treasury. By the end of March 2012, this profit was up to £24 billion. By the end of March 2013, it is expected to have reached £35 billion.
The QE programme means that the Bank of England has large amounts of money that can be used to pay down the deficit by £35 billion over the next 18 months. The £11 billion generated in this financial year will not be handed over to the APF but will go to the Treasury.
Next year, in 2013-14 the other £14 billion will be handed over to the Treasury.
The interest payments that will be given to the Treasury go back to the start of the asset-purchase scheme in 2009.
The Chancellor argues that it is inefficient for the Treasury to borrow money to pay the interest on the £375 billion of gilts purchased by the central bank through the QE programme since the aim of QE is to try and help the overall economy of which government finances are a part.
Sir Mervyn King, the Governor of the Bank of England said that he believes the scheme is a good idea because the QE programme is bigger and will last longer than initially thought.
However, Governor King stressed that the benefits are likely to be short term because reverse payments will be required from the Treasury when the base rate rises and the asset purchase programme is unwound by the Monetary Policy Committee when the economy recovers.
The extra £35 billion that the Treasury will receive would have to be paid back at some point anyway, at the end of the QE programme.
The decision will reduce the government deficit in the short term and lower the interest payments the government pays on the money it has borrowed.
Mr Osborne wants the £35 billion in interest paid on gilts up to the end of the 2012-13 financial year to be repaid to the Treasury in staggered payments. After this time he wants the bank to pay the money to the Treasury quarterly.
Both the Treasury and the Bank of England believe the liabilities will increase when the central bank starts to sell gilts. This will lead to higher debt levels in the long term because future losses will not be able to be offset against interest payments.
Up until now the Bank has set aside the interest payments on gilts in readiness that they will be needed when the economy has recovered and the bonds are sold back to the private sector.