Comments from Rupert Watson, Global Head of Economics & Dynamic Asset Allocation and the team 

This article looks to provide an insight on current affairs through an investment lense.
The Global Economics & Dynamic Asset Allocation team is responsible for creating the Mercer house view on the global economy and markets as well as dynamic asset allocation (DAA) decisions. The team is part of the Global Multi-Asset team led by Andrew McDougall. The team is led by Rupert Watson, Global Head of Economics & DAA, supported by Julius Bendikas, European Head of Economics & DAA and Cameron Systermans, Head of Multi Asset, Asia. The team is supported by seven analysts, each of whom have different specialties.  

Hear from the team

In terms of the size of the losses, it is too early to tell at this point, as the bonds haven’t yet been sold or allowed to mature. However, a guess/forecast can be made based on where yields are today. From quantitative easing’s (QE’s) inception up until March 2021, the BoE made a cumulative profit of £124 billion, according to data from the Office for Budget Responsibility.1 Since then, yields have risen sharply, especially at the short end.

  • Since March 2010, 10-year yields are up about 3%, or down approximately 25% in price. With QE peaking at £895 billion, the losses since then might be approximately £250 billion. 
  • UK GDP was approximately £2.2 trillion in 2022, so losses since March 2022 might be a bit over 10% of GDP. After taking account the gains from QEs inception till March 2022, total losses might be approximately £125 billion or 5%. 

In terms of selling bonds, there are two options that a central bank has to get its balance sheets back to normal. The first option is the slower of the two and involves not reinvesting some/all maturing bonds. The second option is quicker and involves doing option one, but also actively selling bonds. 

Whether option one or two turns out to the best from a financial perspective depends on whether the yield the Banks are selling at now is higher or lower than yields in the future. This, you can imagine, is difficult to forecast. Ex ante there is no right or wrong way of doing it. Although, there is a good argument that a central bank shouldn’t be taking a ‘punt’ on the markets and should thus exit as soon as possible. 

As of writing, the Federal Reserve is not actively selling any of the Treasuries it has bought and its balance sheet should be back to a normal size quite soon. However, the duration/maturity of the BoE’s QE gilt portfolio is a lot longer than the Fed’s. This means that without any active sells, it will remain larger than normal for many years.

The BoE is wholly owned by the government (i.e., the country). This means that any profits go to the Treasury, while the Treasury must meet any losses: the gains/losses are crystalised when the bonds mature and are not based on market prices. From QEs inception until 2022, the government was getting a nice payment each year from the BoE. However, for the next five to ten years the payments will go in the other direction, worsening the government’s annual fiscal numbers. These payments will undoubtedly make things more difficult for the government of the day, especially as budgets are likely to remain strained for several years to come. However, at a high level, is a 5% GDP loss significant? No, it is small in the broader scheme of things. 

It must also be remembered that the purpose of QE was not to make a profit. It was to boost the economy in an environment in which interest rates couldn’t be cut any further. Had the BoE not done QE then the economy would have fared much worse (say many, but not all, commentators). As a result, the loss to government caused by a reduction in tax receipts and various other payments would have been much greater than 5% of GDP. There would also have been significant societal damage caused by high unemployment and other by-products of very weak economic growth.

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