The Chancellor of the Exchequer, Jeremy Hunt, has formally reiterated the government's long-standing commitment to cover any losses arising from the Bank of England's Asset Purchase Facility (APF). This confirmation was conveyed in an exchange of letters between Mr Hunt and the Bank's Governor, Andrew Bailey, underscoring the Treasury's role as indemnifier for the facility established during the global financial crisis.
The APF was originally set up in 2009 to facilitate the Bank of England's quantitative easing (QE) programme, involving the purchase of government bonds (gilts) to inject liquidity into the financial system and stimulate economic activity. The initial purchases were funded by the issuance of Treasury bills, with the aim of reducing long-term interest rates and supporting aggregate demand.
Under the terms of the indemnity, the Treasury agrees to bear any financial losses incurred by the APF, while also receiving any profits generated. This arrangement ensures that the Bank of England can implement monetary policy measures, such as QE and quantitative tightening (QT), without its balance sheet being exposed to undue financial risk. The indemnity is a crucial mechanism that separates the operational execution of monetary policy from direct fiscal implications for the central bank.
In recent years, as the Bank of England has transitioned from QE to quantitative tightening – a process involving the sale of gilts back into the market – and with a backdrop of rising interest rates, the APF has begun to incur losses. These losses arise because the Bank is selling gilts that were purchased at lower interest rates (and thus higher prices) when market interest rates are now higher (meaning lower gilt prices). This situation necessitates the Treasury's indemnification to cover the shortfall.
The exchange of letters serves to publicly reaffirm this established financial backstop. It provides clarity and transparency regarding the financial relationship between the Treasury and the Bank of England concerning the APF, particularly as the UK navigates a period of significant economic change and the unwinding of unconventional monetary policies.
For UK investors and pension holders, the news confirms that the Bank of England’s ability to conduct monetary policy remains unimpeded by potential losses from its past interventions. This stability in the central bank’s operations is vital for maintaining confidence in the financial system and the broader economy, even as the fiscal implications of the APF's losses become more apparent for the Treasury.
Source: Bank of England