Central bank reserves and government's debt interest

The government’s spending on debt interest has been higher in recent years than at any time since the 1980s. It was at a historic low in 2021 but rose rapidly as inflation spiked and interest rates increased.

Some of the recent increase is due to the Bank of England’s (BoE’s) quantitative easing (QE) programme, which affects the government’s spending on debt interest.

Some economists and politicians say the BoE should make changes to reduce QE’s impact on the government’s debt interest spending. In the main, they want the BoE to stop paying interest to commercial banks on some of the central bank reserves that were created to fund QE.

The BoE is against the idea as it says paying interest on central bank reserves is important for setting interest rates in the economy and ensuring financial stability.

What is quantitative easing?

Since 2009, the Bank of England (BoE) has supported the UK economy with a previously unused tool: quantitative easing (QE). QE aims to bring down interest rates on savings and loans to increase spending in the economy.

QE involves the BoE buying government gilts in the open market (the ‘secondary market’). Gilts are a type of loan that the UK Government receives from investors and promises to repay, with interest. They are essentially ‘IOUs’.

Buying lots of government gilts pushes down the interest rate on gilts, and the lower interest rate on gilts helps to reduce interest rates in the rest of the economy. This is because the interest rates on gilts (their yield) acts as a benchmark interest rate for all sort of other financial products.

The BoE created new money to buy the gilts from sellers in the secondary money. The new money was credited to commercial banks’ reserve accounts held at the BoE, which in turn then added it to the gilt seller’s account with a new deposit.

For more information, see the Lords Library’s 2021 briefing on quantitative easing.

What are central bank reserves?

Central bank reserves are deposits commercial banks hold at the Bank of England (BoE) and are used to settle payments between banks. They are also used by the BoE to manage interest rates through tools such as QE and to manage financial stability.

Reserves rose sharply after 2009 because the BoE created them to buy government gilts for its QE programme. There are around £654 billion of central bank reserves as of early-November 2025, compared with roughly £25 billion in 2008, as shown in the chart below.

The BoE pays interest to commercial banks on their central bank reserves. Interest is paid at the BoE’s benchmark rate, Bank Rate.

Source: Bank series YWMB43D

How does QE affect public sector spending on debt interest?

Because the BoE is part of the UK public sector, the BoE’s net interest spending is included in the government’s total debt interest spending.

From the perspective of the government’s debt interest payments, QE is a swap of fixed-rate liabilities (in the form of government gilts) for variable-rate liabilities (in the form of central bank reserves):

• Gilts pay a fixed rate of interest. The BoE receives the fixed interest payments (known as the coupon) from the government for the gilts it holds.
• Interest is paid at Bank Rate on the central bank reserves created to fund QE. The interest paid is variable and is reset every six weeks when the BoE makes its decision on Bank Rate.

This swap was profitable for the public finances when the average rate of interest on the gilts was higher than Bank Rate. Now Bank Rate is higher, the swap is generating an interest rate loss for the BoE and public finances.

Some economists and politicians say the BoE could lower interest losses by adopting new polices, such as reserve tiering.

Tiering: A proposal to lower QE’s impact on debt interest

Tiering reserves would mean paying lower interest (or no interest) on a proportion of central bank reserves. This would lower the amount of interest the BoE pays out on central bank reserves, lowering government’s interest spending.

For tiering to be effective, it’s likely that commercial banks be required to hold a mandated level of reserves. The mandated reserves would receive no interest or interest below Bank Rate. A smaller proportion of reserves would be used by the BoE to influence interest rates in the wider economy and would receive interest at Bank Rate, or very close to it.

Arguments for tiering

Supporters say tiering would lower government spending on interest but would still allow the BoE to control interest rates.

Reform UK says commercial banks are profiting from the interest paid on the reserves created to fund QE and this should be stopped.

Arguments against tiering

Opponents of tiering, including the Governor of the BoE, say it would weaken the BoE’s ability to control interest rates and reduce commercial banks’ incentives to hold reserves for precautionary reasons, which could harm financial stability.

They argue if the government wants to increase commercial banks’ contribution to the public finances it should do so through the traditional means of a tax.

Critics also note that changing remuneration before QE has been fully wound up might affect the BoE’s credibility.

Decision‑making

It’s not 100% clear whether the responsibility for changing reserve renumeration lies with the BoE or the Chancellor of the Exchequer. Wherever the responsibility lies, both parties say they do not want to change the current situation.