Britain’s interest rate vulnerability: Mike Dolan

britains interest rate vulnerability mike dolan

Sumary of Britain’s interest rate vulnerability: Mike Dolan:

  • Breadcrumb Trail Links PMN Business Apr 09, 2021 • 48 minutes ago • 4 minute read • Join the conversation Article content LONDON — Bank of England bond buying may actually increase the speed with which future interest rate rises make UK government debt unbearable and is one glimpse into why central banks need to tread lightly around post-pandemic debt piles for many years..
  • Britain publicly prides itself on keeping the average maturity of its national debt much longer than other major economic powers – sensibly reducing the threat of refinancing crunches, rollover risks and cutting short-term interest rate sensitivity into the bargain..
  • The UK Treasury Debt Management Office claims the average maturity of its total stock of debt was a whopping 14 years at the end of last year – well over twice the U.S..
  • But after warning about the interest rate sensitivity of UK government debt for the past year, the Office for Budget Responsibility (OBR) – the government own budget watchdog – last month detailed just why the seemingly comfortable G7 comparison disguised a counterintuitive effect of the BoE bond buying..
  • The Bank of England (BoE) on-off government bond buying programs since the financial crash 12 years ago, at least partly designed to keep long-term borrowing rates low, basically involve the purchase of gilts from banks in return for interest-bearing reserves at the central bank rather than cash per se..
  • Advertisement Article content And the interest rate on those bank reserves – currently a record low 0.1% – is the very ‘Bank Rate’ the BoE uses to adjust its overall monetary policy and against which so much other household and corporate borrowing rates are referenced..
  • The OBR point is that while the average maturity of outstanding government debt may indeed be 14 years, the length of net debt of the public sector as a whole – including bank reserves held at the BoE – has plummeted as those bank reserves have ballooned over the past decade or more..
  • By the end of next year, the OBR estimated that some 32% of gross government debt – or 875 billion pounds ($1.2 trillion) – will be held in the form of bank reserves..
  • The initial saving for government is obvious – replacing gilts with an average interest rate of 2.1% with bank reserves offering just 0.1% and bagging a net saving of almost 18 billion pounds for the current financial year in the process..
  • “This dramatically increases the sensitivity of debt interest spending to changes in short-term interest rates,”.
  • Already the median maturity is three years lower than the headline average of 14 years and then taking account of the BoE purchases and bank reserves cuts that median to just four years..
  • Adding another several months of BoE buying and including government liabilities overall – such as Treasury bills and savings products – then the median maturity will plummet to less than one year by March 2022..
  • Advertisement Article content The sharp end of the OBR conclusion is that if interest rates and bond yields were 100 basis points higher than assumed over the next five years, debt interest spending would be almost 21 billion pounds higher in 2025-26 – which would be 0.8% of national output and two thirds of the fiscal tightening announced by the Treasury in March..
  • It cushions that by saying if the reason for higher interest rates is much faster growth and higher tax receipts, then the cost will be bearable..
  • Federal Reserve adjusts interest on bank reserves independently of its main policy rate and the European Central Bank and Bank of Japan have some form of tiering of rates too..
  • William Allen at independent UK think tank the National Institute of Economic and Social Research said possible remedies being discussed by leading economists include making bank reserves non-interest bearing while changing BoE policy rate signaling to securities repurchase markets….

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