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Shadow chancellor 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.
Reeves said on Tuesday that Labour had no plans to “tier” the interest paid on the reserves that commercial banks hold at the BoE, which total about £770bn currently.
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 at a press conference she was not interested in changes.
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 [changing the current system] would be without its dangers.”
But 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 circulation.
Reserves are deposits at the central bank, used by commercial lenders to settle payments between each other.
During successive waves of its quantitative easing programme during the global financial crisis and Covid pandemic, the BoE financed purchases of hundreds of billions of pounds of government bonds and other paper held by the private sector — by issuing central bank reserves.
At present, the BoE pays its benchmark interest rate of 5.25 per cent on all the reserves, as it transmits monetary policy into the economy.
Interest earned by the UK’s largest high street banks on their reserves at the BoE surged 135 per cent year on year in 2023, according to figures published by the House of Commons Treasury committee in May.
NatWest, Barclays, Lloyds and Santander collectively received £9.23bn in interest last year from the BoE, the committee said.
Economists have suggested the BoE could shift to a system under which commercial banks are required to hold a fixed amount of money without securing 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. He said last month that the fact central bank reserves were remunerated at the official rate made them “an essential anchor for the implementation of monetary policy”.
The BoE would have to be “very careful how we implemented anything like that,” Bailey added. “That is a pretty substantial change and not one that I would currently advocate.”
The BoE’s benchmark rate sets a floor for the market because if commercial rates fell much below it, banks would borrow money in the market and deposit it at the central bank to earn risk free profits, Bailey added.
“This ‘floor’ system has been successful in keeping money market rates very close to [BoE] bank rate,” he said.
Nigel Farage, leader of rightwing Reform UK party, claimed on Monday that the government could raise £40bn a year from stopping the BoE from paying interest on commercial lenders’ reserves.
UK Finance, a trade body, warned after the arch-Brexiter’s comments 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 Conservative spending plans, which imply cuts to many Whitehall departments after the general election.
On Tuesday she repeated her promise not to increase income tax, value added tax or national insurance.
But Labour has not ruled out rises in capital gains tax, sparking warnings such reform could deter investors from the UK.
