UK Repo Prepares for Lower Rates

By Owain Johnson, CME Group's Managing Director, Global Head of Research and Product Development.

Weak UK economic data and strong employment numbers leave mixed expectations for the next Bank of England rate decision but a new tool predicts the odds of a rate increase or cut from the BoE

The UK repo market is increasingly expecting a cut in interest rates, after the UK posted weak economic data for late 2019.  But the big question remains: how soon any change will come and how extensive any reduction in rates is likely to be.

UK repo participants on CME’s BrokerTec platform, which handles the majority of European repo activity, appear to fall broadly into two camps: those that believe the BoE will cut rates and those that believe they will keep rates steady. Their divided views are in line with the results of the CME BoEWatch Tool, which uses CME MPC SONIA futures prices to gauge market expectations of a change to the Bank of England's policy rate.

The BoEWatch Tool is currently predicting a 52% chance that the Bank of England could announce a cut in interest rates at its next meeting on 30 January and a 48% chance that it will hold rates steady at 0.75%.

This near equal split in probabilities represents a change in sentiment from mid-January, when the tool was skewing heavily towards an increased probability of a cut in rates amid dire economic news from the UK. 

Annual inflation fell to 1.3% in December from 1.5% in November, well below the Bank of England’s 2% target rate. Overall economic growth also fell by 0.3% in November while retail sales volumes fell 0.6% in December. The surprisingly weak data has led to renewed calls for the Bank of England to cut rates quickly in order to head off a further slowdown. 

Silver Linings

But not all repo traders subscribe to the more downbeat view of the UK’s economic prospects. Some analysts are expecting a “Boris Bounce” as the economy responds positively to greater political certainty following Boris Johnson’s overwhelming victory in December’s UK general election.

Optimists are also pointing to positive employment statistics as a sign that the UK is poised for a return to growth. Employment grew by 208,000 in the three months to November, while unemployment remained unchanged at 3.8%, the lowest level since 1975. 

Some economists feel that the relative health of the employment sector is acting as a counterbalance to the recent bearish growth statistics and that this might encourage the Bank of England to hold interest rates steady at their current level of 0.75% or at least incline the Bank to adopt a “wait and see” attitude to potential cuts.

Fence Sitting

The uncertainty around the prospects for UK rates has so far deterred repo market participants from taking longer-term positions.  The current lack of clarity combined with balance sheet constraints has kept the UK repo market focused on very short-dated trading and there have not been any longer-dated UK repo bids or offers on the BrokerTec screen that would suggest positioning ahead of the upcoming meeting.

The Bank of England’s January 30 meeting represents a key determinant for the direction of UK rates and repo in 2020. The market has been nicely poised as we begin the year, although aware that the current environment of low volatility was unlikely to last throughout 2020. 

The Bank of England announcement represents the first potential shift in the current status quo, but with Brexit imminent and the economic picture mixed, UK repo traders are likely expecting further movement as the year progresses.

By Owain Johnson, CME Group's Managing Director, Global Head of Research and Product Development.