Trader says Reeves could make £22bn black hole “magically vanish”

UK borrowing crisis: could taxpayers be spared with a shift in Treasury-BoE relations?

The UK’s public finances have taken a worrying turn as the government recorded a deficit of -£16.6bn in September, significantly surpassing consensus estimates of -£10.3bn and the Office for Budget Responsibility’s (OBR) forecast of -£14.7bn. This deficit also marks an increase from the same period last year, when the shortfall was -£14.5bn. These figures have raised concerns about what lies ahead for the economy, taxpayers, and the upcoming Budget this month.

As the Treasury braces for tough fiscal decisions, experts are scrutinising the relationship between the Treasury and the Bank of England (BoE), highlighting that a less “chummy” arrangement could potentially spare taxpayers from a barrage of tax hikes.

Bond portfolio woes: the indemnity trap

One of the critical issues raised by financial experts is the indemnity agreement between the Treasury and the Bank of England. David Belle, Founder and Trader at Fink Money, pointed out in a Newspage press comment, a key inefficiency in how the UK handles its government debt: “The Bank of England owns about 25% of outstanding government debt. This means that if the BoE were to simply let those bonds mature, rather than offload them, government debt as a percentage of GDP would only be at 92% instead.”

Government debt was equivalent to 100.0% of GDP at the end of August 2024. 

However, the complication arises from an indemnity agreement between the Treasury and the BoE. “The taxpayer is on the hook for these losses,” Belle warned, referring to the fact that if the BoE sells these bonds at a loss, the Treasury — and by extension, the public — would cover the difference.

Belle further questioned why the government persists with such an arrangement, highlighting that if the indemnity were removed, the supposed £22bn ‘black hole’ could “magically vanish,” particularly as interest rates begin to fall.

“Why the government continues to stick to such a silly accounting practice between departments when they can easily fix the issue?” Belle asked, echoing a sentiment that many financial analysts are beginning to share. In other countries, this type of arrangement between the central bank and the treasury is far less common, meaning taxpayers are not always left carrying the burden of central bank losses.

Economic growth vs. tax hikes

As the autumn Budget looms, Rachel Reeves, the Chancellor of the Exchequer, faces an unenviable challenge. With a widening deficit and increased borrowing costs, the likelihood of widespread tax hikes has grown stronger. John Choong, Head of Equities and Markets at Investors Edge, outlined the precarious position Reeves finds herself in: “Reeves must either orchestrate widespread tax hikes to fund Labour’s ambitious spending plans or risk unsettling the bond market with increased bond issuance.”

Given Reeves’ prioritisation of bond market stability, Choong predicted that tax hikes are more likely, a move that could weigh heavily on the British public, still reeling from the cost-of-living crisis. “Unfortunately, this will come at the expense of the British public who are just beginning to recover,” he added.

Ben Perks, Managing Director at Orchard Financial Advisers, echoed concerns over the nation’s borrowing spree, stating, “You can’t borrow yourself out of trouble.” Perks stressed that if the additional borrowing is not strategically invested in projects that generate long-term economic growth, the burden will fall squarely on future generations. He suggested that mindless spending or populist measures will only exacerbate the problem: “Hardworking Britons will have to pay for it down the track.”

The Alternative path: a recalibrated Treasury-BoE relationship?

The UK’s spiralling deficit and the potential for tax hikes have reignited debates over fiscal responsibility and whether a more hands-off relationship between the Treasury and the Bank of England could offer an alternative solution. If the Treasury were to eliminate the indemnity agreement, the public could be insulated from bearing the cost of BoE’s bond sales, allowing the government more flexibility to manage its debt and deficit without immediate resort to tax hikes.

A recalibrated Treasury-BoE relationship could according to commentators also pave the way for more efficient public investment in infrastructure or productivity-enhancing projects, stimulating long-term growth rather than relying on short-term tax revenue fixes. As the government prepares for its next budget, many are hoping for a shift in strategy that balances fiscal discipline with sustainable growth, rather than subjecting taxpayers to yet another round of financial strain.

In the words of David Belle, “This begs the question: why doesn’t the government fix this?” The answer to that could very well shape the future of the UK economy in the coming years.

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