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Rachel Reeves has warned of the “dangers” of overhauling how the Bank of England pays interest to commercial lenders on their deposits, pouring cold water on an idea that some economists have said could help a Labour government find savings.
The shadow chancellor said on Tuesday that the main opposition party had “no plans” to “tier” interest paid on the reserves commercial banks hold at the BoE, which total about £770bn at present.
Such a move, which would have to be enacted by the central bank, could potentially save the public sector billions of pounds a year. But Reeves suggested in a press conference that it was not on the cards.
Asked about the idea, Reeves said: “We have no plans to do that. And actually the paying of interest on reserves is part of the transmission mechanism for monetary policy, it’s one of the ways that higher interest rates filter through to the real economy.”
“I don’t think that that [changing the current system] would be without its dangers,” she added.
The idea of changing the way the BoE pays out interest has risen up the political agenda because of the vast quantities of reserves in the banking system as a legacy of quantitative easing — the programme launched by the BoE under which it bought hundreds of billions of pounds to support the economy.
At present, the BoE pays its benchmark interest rate of 5.25 per cent on all those reserves, as it transmits monetary policy into the economy.
Interest earned by the UK’s largest high street banks on their reserves surged 135 per cent to more than £9bn last year, according to figures published by the House of Commons Treasury select committee in May.
NatWest, Barclays, Lloyds and Santander collectively received £9.23bn in interest on deposits held by the BoE in 2023, the cross-party group of MPs said.
Economists have suggested the BoE could shift to a system under which banks are required to hold a fixed amount of money without interest, while the central bank pays its official rate on only a portion of the reserves.
Michael Saunders, economist at consultancy Oxford Economics, said the savings from such a reform could amount to between £4bn and £5bn a year, depending on where the reserve requirements were fixed.
This would still allow the BoE to set money market rates at whatever level its Monetary Policy Committee wanted, he said, adding: “It is certainly feasible in technical terms. And it’s akin to a tax on banks, of course.”
But BoE governor Andrew Bailey has sounded lukewarm about the idea. In February he told a House of Lords committee that the system of paying the benchmark rate on reserves “anchors the implementation of monetary policy”.
The BoE would have to be “very careful how we implemented anything like that,” Bailey said. “That is a pretty substantial change and not one that I would currently advocate.”
Nigel Farage, leader of rightwing party Reform UK, claimed on Monday that the government could raise £40bn a year from stopping entirely the central bank from paying interest on commercial lenders’ reserves.
UK Finance, the bankers’ trade body, warned after the arch-Brexiter’s intervention that changing the approach could lead to higher banking costs for consumers and businesses.
Reeves is under pressure to clarify whether a Labour government would put up taxes or accept existing government spending plans, involving cuts to most departments after the election on July 4.
On Tuesday she repeated her promise not to lift income tax, VAT or National Insurance and declared: “I want taxes to be lower.”
However Labour has not ruled out increases in other taxes, such as capital gains tax, sparking warnings that a rise could deter investors from the UK and push entrepreneurs to sell businesses.
https://www.ft.com/content/11bdb2f6-e478-462f-b205-470f44679c91
