The omens aren’t good for ‘Britcoin’, the Bank’s digital pound

Let me take these two questions in turn. The digital pound was first mooted early this decade, partly because of the decline in the use of cash and partly because of concern that, in an era of digital transactions, the monetary system would lose its official bulwark.

“A digital pound would be like a digital form of cash — a banknote for the digital era,” the Bank says on its website. “Like banknotes, it would be issued directly by the Bank of England. You could hold your digital pounds in a digital wallet and spend them in shops or online.”

Lately, however, the question of whether we will ever see it has come to the fore. In his Mansion House speech on July 15, Bank governor Andrew Bailey was lukewarm to the point of icy about it. Emphasising the need for private sector innovation in payments systems, on which the Bank is working with the industry, he said: “Perhaps there may also be a role for a retail central bank digital currency, but I remain to be convinced why the natural next step is to create a new form of money, rather than put digital technology into retail payments and bank accounts.”

I think he is right. In a piece I wrote in The Times a couple of years ago, I asked why anybody would bother loading up a digital wallet with digital pounds, when they could already quite happily pay digitally, using their smartphone or contactless card. Further innovation in payments will provide even less incentive to use digital pounds.

Bailey’s comments have fuelled reports that the digital pound is already dead, which the Bank denies, insisting that the work goes on under the supervision of one of its deputy governors, Sarah Breeden. A decision will be made next year. Even so, the odds, I would say, are against it seeing the light of day.

Before that, there is another decision for the Bank. You will know that in the wake of the global financial crisis, it undertook quantitative easing (QE) — creating money, in the form of bank reserves, in order to purchase assets, which were overwhelmingly government bonds (gilts).

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QE, first undertaken in March 2009, was what the Bank did when it deemed that it could not cut interest rates further. The first tranche of QE worked, helping the economy recover from recession. The third tranche of quantitative easing, in response to the pandemic (there was a smaller bout after the Brexit referendum in 2016), was rather less successful. It was a different kind of crisis, and the very large additional amount of QE was probably the wrong response.

At its peak, the Bank had undertaken £895 billion of QE, of which £875 billion was in gilts, the rest corporate bonds. Then, three years ago, it switched to reversing the policy. QT replaced QE, the tightening of monetary policy replaced easing it. So far, about a third has been unwound: last month, the stock of government bonds held for monetary policy purposes was down to £590 billion.

This is where a big decision is coming up. On September 18, the Bank will announce how much QT it intends to do over the next 12 months; for the past two years, it has done £100 billion a year. There are two types of QT: “passive”, where the proceeds of maturing gilts held by a central bank in its portfolio are not reinvested; and “active”, under which a bank sells gilts into the market.

Other major central banks have been undertaking passive QT. But only those of Sweden and New Zealand — which, if they will forgive me, are not regarded as “major” — have been doing active sales as well as the Bank of England.

This has not been much of an issue over the past 12 months because most of the £100 billion of QT in Britain has been passive; there have been many maturing gilts. But if the Bank stuck with £100 billion over the next 12 months, about half would constitute active sales.

Therein lies the problem. The UK has the highest government bond yields among advanced economies — interestingly, vying with New Zealand for that position. When QT started three years ago, it was expected that it would coincide with rapidly falling government borrowing. That, though, has not happened, so in addition to the supply of gilts from high levels of government borrowing, there is supply from the Bank’s QT sales.

This tension has already been recognised, with the recent cancellation of a planned auction by the Bank of long-dated gilts.

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Sanjay Rana, senior economist at Deutsche Bank in London, expects the Bank to try to square this circle by opting for £75 billion of QT over the 12 months from September, in line with market expectations. In a detailed research note, he also estimates that the Bank has in the past three years cost the Treasury £90 billion — £57 billion in interest costs and £37 billion from valuation losses on gilts.

The point at which these losses exceed the earlier profits that the Treasury made from QE is fast approaching, and then this could become an even bigger issue.

Michael Saunders, the former MPC member who is now a senior adviser to Oxford Economics, also expects a significant reduction in QT in the coming 12 months, to between £75 billion and £80 billion. He thinks it possible, too, that the Bank will say that it will never sell its holdings of very long-dated gilts — those with more than 20 years to maturity — to ease pressures on long-term interest rates.

Whether that happens or not, the QE-QT episode of “unconventional” monetary policy, controversial when embarked upon more than a decade and a half ago, will continue to attract considerable controversy. The Bank probably can’t win.

PS

One of the biggest email responses I have had for some time happened last Sunday. This was not triggered by my main piece, which suggested people were panicking unnecessarily over mildly disappointing economic news.

No, it was my suggestion that reducing the annual £20,000 limit on investing tax-free in cash Isas, while leaving it unchanged on stocks and shares Isas, made economic sense. I was not suggesting cash Isas should be sent to the knacker’s yard, merely that the extent of the taxpayer subsidy should be reduced.

Many of the emails made a similar point: equity Isas, which by their very nature carry higher risk, are not suitable for many people, particularly older savers, who may not have the luxury of waiting for the longer-term outperformance of equities to assert itself.

That is fine. Nobody is suggesting they must take up stocks and shares Isas. And they would continue to benefit from the generous cash Isa limits of previous years; any change would not be retrospective. In addition, the life-cycle hypothesis we were taught as economics students suggested that older people should be running down their savings, not adding significantly to them every year.

But if there is a lesson here for Rachel Reeves, it is that many older people are as attached to their cash Isas as they were to their winter fuel payments.

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A better argument was provided by Adrian Coles, former director-general of the Building Societies Association. He pointed out that money in cash Isas does not lie dormant but boosts the economy via mortgage and business lending; it provides the funds for the lenders to lend on. Without such a supply of cash Isa funds, deposit-takers would be forced to raise interest rates, making lending more expensive and depressing the economy.

It is a good point. Does money in cash Isas boost the economy by more or less than that placed in their stocks and shares Isas, the lion’s share of which is likely to be invested in overseas equity markets? We still have a few weeks to debate it.

david.smith@sunday-times.co.uk