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Shadow Chancellor Rachel Reeves has warned of the “dangers” of overhauling the way 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 Labor government help you find savings.
Reeves said on Tuesday that Labor has no plans to ‘tier’ the interest paid on the reserves commercial banks hold with the BoE, which currently stand at around £770bn.
Such a move, which would have to be implemented by the central bank, could potentially save the public sector billions of pounds a year, but Reeves suggested at a press conference that she was not interested in changes.
Asked about the idea, Reeves said: “We have no plans to do that. And actually, paying interest on reserves is part of the transmission mechanism of monetary policy; it is one of the ways in which higher interest rates trickle down to the real economy.
“I do not think so [changing the current system] would be without danger.”
But the idea of changing the way the BoE pays out interest has moved up the political agenda because of the huge amounts of reserves in circulation.
Reserves are deposits with the central bank, which are used by commercial lenders to settle payments between them.
During successive waves of its quantitative easing program during the global financial crisis and the Covid pandemic, the BoE financed purchases of hundreds of billions of pounds of government bonds and other paper held by the private sector – through the issuance of central bank reserves.
Currently, the BoE pays its benchmark interest rate of 5.25 percent on all reserves, while transmitting monetary policy to the economy.
The interest earned by the largest British banks on their reserves at the BoE rose by 135 percent year on year in 2023, according to figures published by the House of Commons Finance Committee in May.
NatWest, Barclays, Lloyds and Santander together received £9.23 billion in interest from the BoE last year, the commission said.
Economists have suggested that the BoE could move to a system where commercial banks are required to hold a fixed amount of money with no interest rate guarantee, while the central bank pays its official interest only on part of its reserves.
Michael Saunders, economist at consultancy Oxford Economics, said savings from such a reform could amount to between £4 billion and £5 billion a year, depending on where reserve requirements were set.
This would still allow the BoE to set money market rates at whatever level its Monetary Policy Committee wishes, he said, adding: “Technically it is certainly feasible. And of course it looks like a tax on banks.”
But BoE Governor Andrew Bailey sounded lukewarm on the idea. He said last month that the fact that central banks’ reserves are remunerated at official rates makes them “an essential anchor for the implementation of monetary policy.”
The BoE would have to be “very careful about how we implement something like this,” Bailey added. “That’s a pretty substantial change and not something I would advocate for at this time.”
The BoE’s benchmark rate sets a floor for the market because if commercial rates fell far below that, banks would borrow money from the market and deposit it with the central bank to make risk-free profits, Bailey added.
“This ‘floor’ system has been successful in keeping us very close to money market rates [BoE] bank interest,” he said.
Nigel Farage, leader of the right-wing Reform UK party, claimed on Monday that the government could raise £40 billion a year by stopping the BoE from paying interest on commercial lenders’ reserves.
UK Finance, a trade body, warned after the arch-Brexiter’s comments that changing its approach could lead to higher banking costs for consumers and businesses.
Reeves is under pressure to clarify whether a Labor government would raise taxes or accept Conservative spending plans, which involve cuts to many Whitehall departments after the general election.
On Tuesday she repeated her promise not to increase income tax, sales tax and national insurance.
But Labor has not ruled out a rise in capital gains tax, prompting warnings that such reforms could deter investors from Britain.