The Bank of England has now reversed £300 billion of Quantitative Easing

... but it still hasn't got back to March 2020 levels, that will need another £200 billion of asset purchases to be reversed.

Here is the chart:

source

Inflation is at 3.8%, nearly double the BoE's 2% target, so the BoE clearly hasn't done enough Quantitative Tightening.

Why did the BoE do QE in the first place?

To go back to first principles, inflation is a function of the quantity of money in circulation x the velocity of money (how fast money circulates in the economy).

Most money in circulation in the economy is created by the retail and commercial banks through fractional reserve lending. The BoE can influence this by raising or lowering the level of reserves the banks hold (dictating the supply of lending), and by raising and lowering the bank base rate (influencing the demand for borrowing).

The problem the BoE had in the Great Financial Crash and during the Covid lockdowns, was that even though the bank base rate was a historically low 0.25%, banks were too scared to lend and households were too scared to borrow. Instead of borrowing and spending, they were saving and paying off debt.

If the money supply created by the retail banks is shrinking (due to reduced lending and increased repayments) and the velocity/circulation of money is reduced (due to people cutting back spending), you get into a deflationary spiral.

So governments expanded borrowing, and the BoE facilitated this by printing money and buying the gilts in the secondary market (this is Quantitative Easing). So in a convoluted way the BoE was lending printed money to the govt. So the money supply expanded due to QE and the govt spent the borrowed money, so it circulated. Deflation averted.

This Asset Purchase Facility, as it was called, was indemnified by HM Treasury. If the BoE made a profit from buying bonds, this profit was passed to the Treasury. If they made a loss, the Treasury would pass money to the BoE to make up for the loss. (When George Osborne was Chancellor, he was helped greatly by profits flowing from the BoE to the Treasury. Part of the reason Jeremy Hunt and Rachel Reeves were/are constrained is because QT is under way and billions are flowing from the Treasury budget to the BoE to compensate for the BoE's losses).

When lockdown ended in June 2021, the private sector burst into life with a vengeance. They were eagerly spending, eagerly borrowing at the historically low interest rates, banks were eagerly lending.

The Johnson and Sunak govts tried to cool this down with spending cuts and tax rises (corporation tax was jacked up from 19% to 25%, and income tax thresholds were frozen), to reduce circulation of money.

The Bank of England fatally hesitated: They made no attempt to curb private sector lending exuberance. They finally raised rates from 0.25% to 0.5% in Feb 2022. The market had expected them to start raising rates in Oct 2021.

Andy Haldane was the lone member of the BoE arguing for a halt in QE in May 2021. In August 2021 they stopped QE and decided to do "passive QT" (allowing maturities to run off the books). It wasn't till Sept 2022 that they acknowledged the snail's pace of passive QT was hopeless, and started doing active QT, where they sell their gilts in the open markets and destroy the money received (the opposite of printing money).

Inflation took off because there was a fatal period from June 2021 to Sept 2022 where the private-sector-created money supply was expanding at the same time as a vast BoE-created money supply was sloshing around.

Undoing it all is painful. No-one likes interest rate rises, no-one likes spending cuts, no-one likes tax rises.

Labour backbenchers argue for more borrowing and spending. Reform's Richard Tice argues that the indemnity the Treasury gives to the BoE should end, which would mean the Treasury would no longer be sending billions to the BoE to be destroyed (currently about £13bn annually). But if you stop the indemnity, how do you get the printed money out of the system? How would you discipline the govt to curb spending?

Because inflation is still a problem, and the BoE has probably been unwise with it's recent base rate cuts.

In September 2025, the BoE has to make a decision of how they do QT in the subsequent year. It is expected that they will slow it down to ease pressure on the govt. But that means too much money sloshing around for longer, and persistent inflation.