This article was originally published in February 2021.

Standing at close to £759bn, the ‘stock’ of UK state debt acquired by the Bank of England on behalf of the state is not merely a considerable number but, to many, a monetary time-bomb. Indeed, I am often challenged with the question: when the Bank of England ‘deals’ with the debt it has landed itself with, what host of problems will this land the UK economy in? My answer to this has been stubbornly consistent: we needn’t be worried by what the BoE does with ‘our debt’. Before making a case for such a seemingly blithe answer, let me turn the clock back to why the Bank of England acted as it did over a decade ago.

The simple fact is that, after the unprecedented banking shocks by which the UK economy was suddenly and so dramatically hit from 2007, it needed a sizeable infusion of liquidity. Far more sizeable in fact than what could be achieved even with the dramatic and timely cuts to the base rate that were actioned.

Quite frankly, then, UK near-ZIRP/QE was the quick and effective way for the Bank of England to achieve the essential injection of money the UK economy most desperately needed, for reasons best explained by a very simple factor model.

Stripped down to its skeleton, a ‘flowing’ economy depends on this factor: the STOCK OF MONEY multiplied by its VELOCITY OF CIRCULATION. The latter is simple enough to understand; we never choose to retain every pound we earn, but spend a portion of it. This portion goes on to become income elsewhere, a part of which is in turn spent and so on, such that £1 moving around at 90% velocity sums to total income of £10. When real interest rates are high and/or our confidence in the future is low, we are more inclined to slow the speed we CIRCULATE our MONEY. With this in mind, when the events of 2008 so dramatically struck, UK household and business confidence was so seriously undermined that the monetary policy committee immediately and very wisely stepped in and slashed interest rates in an effort to mitigate matters. So much, then, for much looser conventional monetary policy helping to restart the practically stalled VELOCITY OF CIRCULATION. The problem back in 2008 was that the STOCK OF MONEY too fell dramatically.

To understand what happened, one has to embrace how we consider our STOCK OF MONEY as not merely in terms of the notes and coins to which we have immediate access, but what we consider CLOSE MONEY.

Please reflect for a moment on how British homeowners seem incapable of passing an estate agency window without glancing in at it. This is not to look at our physical appearance but rather to check out our financial image, as reflected by our local property prices showing how much equity we have in ‘our’ (very often mortgage-laden) home. In the wake of the 2008 shock, the image we saw was bleak. The same image of negative equity had, as we sadly remembered, appeared in the past, most notably back in 1989. What differed so much in 2008, and so much for the better compared with 1989, was that the UK’s monetary policy had shifted out of amateurish and ‘handcuffed’ chancellorial hands, into extremely professional and agile Bank of England ones (we were so fortunate to have the likes of Professor Charlie Bean as chief economist and deputy governor all those difficult years ago).

Conscious in 2009 that the perception across households and businesses in the UK was that our STOCK OF MONEY had fallen precipitously, the Bank of England very reasonably utilised unconventional money policy to inject NEW MONEY into the economy; a programme we all have come to know as QE (quantitative easing). Since then it has used this twice more to ‘come to our economic rescue’.

The MPC cut the base rate and reignited QE modestly after the shock Brexit referendum result, and has done so again much more aggressively in the wake of the current crisis. While I for one saw little justification for performing QE back in 2016 – Mark Carney engaging in hero syndrome – I consider it perfectly justified this time around; indeed, failure would have been unconscionable. This of course still leaves unanswered the question of what to do with the legacy of around£800bn of UK state debt that the BoE has acquired over the last decade and more.

Well, for one thing, just because the Bank of England acquired the amount of our debt that it has, doesn’t mean it still holds all of it. The reality after all is that some of the gilts acquired by the BoE over more than a decade will have come due. As a result these would have simply been ‘retired’; or in effect generously gifted back to the Treasury for it to write off (I think of it as tearing up an IOU). This is merely one piece of fiduciary good news for indebted Britain.

Gilts carry a value, and the prices the BoE has paid for its purchases have for the most part been less than such paper currently now sells for. Another positive fiscal point invariably ignored is that as the bearer of our state bonds, the BoE has earned the coupon we pay to all holders of our gilts. And this too will have been gifted to the Treasury.

In short, then, be in no doubt that the BoE is sitting on a very sizeable notional profit from its QE gilt programme, having already gifted windfalls to the Treasury. This is the reason for my stock answer to the question of what the BoE should do with its stock of UK state debt? We needn’t be worried by what it does. I make this claim because I do not foresee any particularly unpleasant rise in gilt yields, and so do not fear any material fall in the BoE’s considerable ‘book profit’. After all, with the world’s appetite for dollar savings waning fast, so demand for sovereign debt such as the UK’s can only rise from here, and with it too the value of the pound. This brings me to consideration of UK inflation and the base rate.

I have absolutely no doubt that the UK base rate not only will not go negative, but will move up from a near-ZIRP (0.1%) – albeit merely back towards its pre-coronavirus crisis level of 0.75% – long before the close of 2022.

I see the base rate’s move out of emergency territory coming about as a result of the UK economy emerging with confidence from this seemingly interminable lockdown. The recovery in household and business confidence will sufficiently spur on the circulation of our money – bearing in mind UK households hold considerably more savings than they would like – not to require the ultra-low base rate we currently have.

As for consumer price inflation, I have no doubt that while this will move to the upper part of the Bank of England’s desired 1%-3% range, it will not threaten to break above it in any sustained way.

Part of my confidence for my contained consumer price claim is the inflation-calming rise in sterling that I have no doubt we will continue to witness. Part too (sic) of my confidence consumer-price inflation will be contained is the continued disinflationary forces resulting from the disintermediating effects of our ever-growing use of e-commerce. For while we are the most ‘penetrated’ of all Europe and indeed beyond, this lockdown has forced a great many of those who had previously used e-commerce in a modest fashion to engage in it so much more, with much of this shift set to stick.

A third string to my consumer price moderation confidence is the way I believe this chancellor – and I view him as among the best-qualified this nation has had in many, many decades – will justly adjust our fiscal landscape. Yes, he will introduce an entirely new sales-tax regime that more effectively and equitably captures e-commerce. Rather than new taxes proving inflationary, I believe they will be for the very most part absorbed by the e-commerce sector into its considerable net margins. Furthermore, I believe such nascent taxes will actually only add to confidence in sterling-based markets, both gilts directly and the pound itself, and in so doing will help to contain inflation and yields.

There is a fourth element as to why I am strongly minded to expect UK consumer price inflation to be NICE (Non-Inflationary, Consistently Expansionary – a term coined, albeit prematurely, by Mervyn King in 2003).

As we unlock the doors to our spending on all aspects of household goods and services, the temptation to raise prices in the face of all this will, I am confident, be contained by this additional development. All the market places benefiting from the unleashing of our suppressed desires will not merely remain highly competitive because of e-commerce, but will be made all the more so by new business arrivals to our high streets, shopping centres and retail and leisure parks. All such newcomers will be keen to establish their market presence, and be unburdened by legacy liabilities, pricing for operationally geared profit growth and thus helping to keep inflation contained.

So to recap, I believe the MPC will vote sooner than the consensus expects to lift the base rate from its emergency near-ZIRP of 0.1%. I am writing here of a shift up to, say, 0.25%, before then 0.5% and ahead of the end of 2022 back up to its pre-crisis 0.75%. Such calculated moves should not, however, be viewed as cause for concern, but rather as a vote of confidence in the health of the UK economy.

If I can make a penultimate point on the risk or otherwise of target-beating UK consumer price inflation, it is this: I would much rather see UK CPI inflation moving towards 3% than head towards 0%. While I do not fear the UK falling through the zero inflation trapdoor, I sadly do see much of the eurozone’s Club Med economies doing so (bear in mind that the money we have hoarded by being denied trips abroad is income being denied to those abroad). So although I am confident the UK will easily avoid negative interest rates, I believe the eurozone will not. This is, in fact, a central reason why I see sterling quickly moving up towards €1.3, a factor that I have already claimed will help contain UK consumer price inflation to the comfortable 2%-3% territory.

In summarising, I am not ignoring the medical and monetary ills that this accursed virus has inflicted on many across the UK. This said, the truth is that in aggregate, our households have enjoyed considerable savings windfalls thanks to so much of their income being protected by the state, and their outgoings very much contained by being locked in and locked out.

The unleashing of what, when the time comes to unlock, will amount to at least £300bn of savings is the cornerstone for my confidence in a swift UK economic recovery, as measured by GDP and reflected in a rapid and widespread labour market rebound. As well as reflating the price of goods and services, enforced savings will be deployed into lifting asset prices, not merely UK properties but equities too. UK households and investors will not, however, have it all their own way in this regard. Rather than enjoying monopsonist power, we will find that our properties and equities will become highly sought targets by those overseas.