THE BANK OF ENGLAND WILL BE HANDING OUT a stealth subsidy of £57 billion to the banking sector over the next three years if interest rates continue to rise as planned, according to a report by the New Economics Foundation (NEF)..

Against the backdrop of the extreme rise in the cost of living, this massive payment to commercial banks would be enough to fully retrofit over 19 million UK homes or send every household a £2000 cheque, cancelling out the rise in the energy price cap. It is almost quadruple the amount announced in May by the chancellor to help struggling families with the cost of living.

The report sheds light on the fact that, when interest rates rise, the Bank of England sends greater amounts of money to the banking sector, despite the sector not providing any additional services, boosting the profits of commercial banks at the government’s expense. The Bank will make its next decision on interest rates on Thursday, and will be looking to use interest rates to influence the high levels of inflation causing the cost of living crisis.

Interest rates are expected to rise to 2.5 per cent by next summer, and then fall to 2.0 per cent by January 2025. The report finds that this would result in the Bank sending commercial banks £15.08 billion of public money by 2023 and £57.03 billion by 2025 even as the quantitative easing policy is unwound. These significant payments will most likely boost the profits of the banking sector, where pay rises were treble the national average last year, the report finds.

When the Bank’s interest rate rises, the Bank has to pay a higher amount to commercial banks for holding central bank reserves. The banking sector currently holds nearly £1 trillion of central bank money as a result of the money creation programme known as quantitative easing.

Interest payments on all central bank reserves were introduced in 2009, as a response to the global financial crisis. The report argues that this is historically unusual: in 2009, unlike today, inflation levels were dangerously low and central bank reserves were much smaller. Prior to the 2007 – 2008 financial crisis, the Bank of England did not pay interest on all the reserves held by banks.

The NEF report argues that this policy is out-of-date, unnecessarily expensive and in need of a reboot. The report proposes the Bank of England imitate the Eurozone and Japan by implementing what is known as a tiered reserves policy framework, by only paying interest on a portion of central bank reserves, or stopping paying interest all together. The report finds that this is a more nuanced way of controlling inflation that could save the government £10 – 15 billion by March 2023, and £25 – 57bn by March 2025.

The report finds that the stealth subsidies sent to the banking sector by 2025 would be enough for the government to either:

  • Reverse all cuts to social security since 2010;
  • Fully insulate and upgrade over 19 million UK homes;
  • Send every household in the UK £2000.

Frank Van Lerven, senior economist at the New Economics Foundation, said: While families up and down the country are worrying about how they will afford their next grocery shop or energy bill, the Bank of England will be busy sending billions to bankers.

“It’s only been a matter of years since we didn’t have to pay interest on our central bank reserves – this is an exception, not the historic norm. We are left with a dangerously out-of-date policy which isn’t designed to address the challenges of today’s economy – a reserves policy that pays no interest would be a better way of controlling inflation.”

* Read the report, Between a rock and a hard place. The case for a tiered reserve here.

* Source: New Economics Foundation