The UK Economy in Double Jeopardy
Published 28th September 2024
It seems no one at HM Treasury or the Bank of England has adequately informed Chancellor Rachel Reeves of the looming double jeopardy facing the UK economy.
This situation arises due to the Bank of England’s shift from the Capital Requirements Directive (CRD) to a Bank Levy.
In this analysis, I will outline how these policies could create compounded difficulties for both banks and the Treasury—potentially leading to economic instability, or “Is It Me!”
Anthony Royd
The UK’s National Debt
The UK’s national debt stands at a staggering £2.7 trillion, with £111 billion spent last year on servicing this debt— This alarming figure was confirmed by the Office for Budget Responsibility [OBR] in April 2024
Under the current Labour government, borrowing in August 2024 was £3.3 billion higher than in August 2023, marking the third-highest borrowing level for August since records began in 1993 [ONS] — The national debt is now almost equal to the country’s GDP, and the government is reportedly considering altering fiscal rules to allow for even more borrowing.
Signs of Trouble in the Economy
The effects are already visible— particularly in the housing sector, where ‘new housing starts’ have slumped by 34% in the first quarter of 2024 compared to the previous year.
This amounts to just under 30,000 houses, far below the government’s target of 300,000 [Construction Enquirer]— This contraction in housing development is an early warning of broader economic challenges.
Understanding the Double Jeopardy— Bank Reserves and Treasury Burdens
“Double jeopardy” in financial terms refers to facing two simultaneous risks— In this context, it highlights the compounded challenges posed by the Bank of England’s high-interest payments on its Asset Purchase Facility (APF) and the introduction of the Bank Levy, which replaced the CRD. (discussed in detail— UK Monetary Policy)
These actions pose dual threats to both the banking sector and the Treasury.
The Burden of High Interest Payments by the Bank of England
The Bank of England holds nearly £700 billion in its APF and currently pays interest on these assets at the prevailing Bank Base Rate— The switch from CRD to Bank Levy was meant to ensure banks maintain enough capital buffers to absorb losses, reducing the risk of taxpayer bailouts— However, this strategy has led to unintended consequences.
The Economic Risks of Reduced Lending and Bank Profitability
When banks hold large excess reserves without effectively lending or investing, it introduces several risks:
Reduced Lending Activity— With fewer loans issued, economic activity slows, stalling growth and reducing tax revenues.
Interest Payments Burden— High interest paid by the Bank of England on APF reserves adds strain to public finances. If banks aren’t earning sufficient returns from their investments or loans, their profitability suffers.
Challenges for Banks and the Treasury
Banks face major challenges from holding excess reserves
Opportunity Costs— Funds tied up in reserves could otherwise be used for profitable loans or investments.
Profitability Concerns— With low returns on excess reserves, banks’ profitability declines, reducing their tax contributions to the Treasury.
For the Treasury, these trends present serious concerns
Reduced Tax Revenue— As bank profits fall, so do their contributions to government revenue.
Increased Borrowing— Lower tax revenue forces the Treasury to borrow more, further escalating the national debt.
Economic Instability— Prolonged periods of weak bank performance can lead to broader economic instability, affecting employment and consumer confidence.
Conclusion — The Dangers of Double Jeopardy
The Bank of England’s switch from Cash Ratio Deposit to the Bank Levy creates a double jeopardy situation— High interest payments on reserves and declining returns from reduced lending have put both banks and the Treasury in a precarious position— The resulting strain on public finances could lead to broader economic instability, or “Is It Me!”