We still see the Bank of England (BoE) cutting rates once more this year, although investors have turned more sceptical. The market implied probability for another cut by the end of this year has dropped to around 50% on the back of sticky inflation numbers and relatively good economic data. But the BoE landing zone is still priced at 3.5%, which means the money market curve offers a decent yield pickup for shorter maturities. From a strategy perspective, however, we prefer to position further out on the curve as we see scope for easing to 3.25%, below market expectations.
In the September meeting, the BoE will also decide on the pace of quantitative tightening (QT) going forward, which could have implications for liquidity conditions. Interestingly, the likely decision to lower the pace of the gilt portfolio unwind from the current £100bn per year seems more driven by the recent moves in longer-dated gilt yields rather than tighter liquidity. The 30Y gilt yield is already at new records and with (global) fiscal pressures pushing yields higher, the BoE wants to prevent excessive stress in the gilt market.
If the Bank of England reduces the pace of the unwind of the bond portfolio, then liquidity should remain ample for even longer. Whilst QT is draining bank reserves, the repo liquidity facilities, STR and ILTRO, are adding reserves to the system. In fact, over the past year, these two facilities added around £70bn of reserves, offsetting a significant portion of the QT impact. This should keep money markets in a relatively good place in terms of liquidity supply.