EU Central Bank Raises Interest Rates

 Today on the 27th July 2023, the European Central bank, perhaps not unsurprisingly, decided to raise interest rates by 0.25%.  This takes it to 4.25%

Comparing the bulletin with the Bank of England shows that the EU Central Banks does very little explaining for their decision.  In fact what data it has provided would be deemed positive in the fight against inflation:

"Inflation continues to decline"

"Our past rate increases continue to be transmitted forcefully: financing conditions have tightened again and are increasingly dampening demand"

"The near-term economic outlook for the euro area has deteriorated, owing largely to weaker domestic demand. High inflation and tighter financing conditions are dampening spending. This is weighing especially on manufacturing output, which is also being held down by weak external demand. Housing and business investment are showing signs of weakness as well."

Yet it increased interest rates. ?

Increasingly it's looking like we are entering a potentially global period of stagflation

Stagflation is a period of high or rising inflation but falling economic output.

The description above looks like that's exactly where we are.

However the thing that caught my eye was the comment "We also decided to set the remuneration of minimum reserves at zero per cent."

I was curious was is this "remuneration of minimum reserves"?

Well the EU central bank pays banks interest for the money  they are required to hold to meet the solvency and liquidity requirements. 

I then became curious whether the Bank of England also pays UK banks interest for their reserves.

Well it seems the answer is yes. This article from the National Institue of Economic and Social Research covers it.

On paper I can see the logic of this - we dont want another banking crisis or banks to fail however I am aware that back in 2008, vast sums of money were printed with quantitative easing and this was given to the banks.  This money was lent (maybe given) to the banks to artificially inflate their reserves and make them have higher liquidity and meet the banking solvency stress tests.  Now normally printing lots of money is bad news for inflation however this was special money.  The banks agreed never to lend it to anyone (ie doesnt make it's way into the economy) and simply keep this money as reserves to make their balance sheets look very solvent.

However the discovery that the Bank of England is paying interest for banks to take care of the Bank of England's (actually read tax payers) money is a bit of a surprise. 

I was under the impression that the Bank of England was the lender of last resort ie no-one else would lend to you however it seems the commercial terms for borrowing large sums of liquidity were somewhat more generous.

According to the BoE on 22nd Feb 2023 "The minimum quantity of reserves needed by UK banks may be around £325 billion to £480 billion".   Big numbers.

Now lets take the lower number of £325Bn  and assume the BoE is paying the current BoE base rate of 5% then that equates to £16Bn in interest payments to the UK banks. That's 2% of all tax revenues or to put it in different terms that's equivalent to the tax income from inheritance tax (£7.2 Billion) plus the Excise duty on smoking that raises over £8.8 billion in taxes per year.  Stamp duty taxes on property transactions raises £14Bn so with the higher number of £480Bn in minimum reserves, that equates to all stamp duty taxes and inheritance tax revenue flowing straight out of the treasury into the banks. 

I thought can this be right?  Ill take a look at the BoE annual accounts.  Nothing in there. That's because the debt is held in something called the "Asset Purchase Facility".  It's a separate (limited) company registered with Companies House. So I downloaded the annual report.  

It states the quantitative easing to banks was £119.7 billion on 28th Feb 2022.  It holds gilts valued at £874.9 billion.  To put that into perspective, the largest companies on the FTSE are BHP which has a market cap of £123Bn and Astra Zeneca which has a market cap of £165Bn.  This is bigger than both these companies combined.....This is a serious company which most people will have never have heard of.

The accounts are hard to understand as lots of money is flowing in from the treasury however it looks like it make a trading loss of £117Bn....Highly likely then it is paying the £16Bn in interest payments to the banks then.  I'm happy to be proven wrong and that our hard earned taxpayer money is not being given to the banks.

Do they think we are stupid?