(Bloomberg) -- The Bank of England expects to halve the size of its quantitative-easing portfolio to around £400 billion ($500 billion) over the next few years as commercial banks trim their demand for the safest of central bank assets, according to an internal BOE analysis.

The research found that UK lenders will need to hold in the long-term between £325 billion and £480 billion of reserves, a form of central bank deposit. Reserves ballooned in the financial crisis and pandemic as they were created as part of QE so the BOE could buy assets.

While the paper doesn’t represent official BOE policy, it’s the most specific figure yet to emerge about how far the central bank’s reserves will decline as the QE program winds down. Governor Andrew Bailey has been reluctant to put a figure on how big the balance sheet will be. Last week, he said it will decline significantly but not to the level it was before QE began in 2009, when it stood at less than £50 billion.

The BOE’s latest weekly accounts show £888 billion of reserves, suggesting the BOE plans to cancel at least £400 billion worth as it runs down QE. It is currently shrinking the portfolio by £80 billion a year. At that pace, the balance sheet may not stabilize until 2028 at the earliest.

At its peak, the bank had bought £895 billion of gilts and corporate bonds but has been reducing the portfolio since February last year. The program now stands at £814 billion.

Governor Andrew Bailey insists the BOE will feel its way through the run-off and only stop when it meets resistance in the markets. The bank has set up a separate liquidity facility to deal with any market volatility if that happens.

Another reason the BOE has been reluctant to set a stable level of reserves is that doing so would imply the rest is excess. A number of senior economists including former BOE deputy governor, Paul Tucker, have proposed a tiering system under which no interest is paid on excess reserves.

Government Indemnity

QE has proved to be a hugely expensive program for the government, which indemnified the BOE against losses. 

Between 2009 and 2021, the government made about £120 billion as the income from the bonds was higher than the interest paid on reserves.

Since the BOE started raising rates in December 2021, though, the situation has reversed. The BOE expects to incur over £200 billion of losses from QE in the next decade. Scrapping interest payments on a share of the reserves would save the government billions of pounds.

In a paper for the Institute for Fiscal Studies last year, Tucker argued that a tiering system was plausible and would not interfere with the operation of monetary policy, The BOE has insisted that it would act like a tax on the commercial banks and is a decision for the Treasury.

The BOE declined to comment beyond the internal analysis published on its Bank Overground website.

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