Rates · R4 · 9 min
Money markets, repo and the expected policy path
Price a Treasury bill, work out repo interest, and read from market prices what traders expect the Bank of England to do next.
In the news: “Markets price a 60% chance of a rate cut at the next Bank of England meeting”: where that number comes from.
The essentials
- Bank Rate and SONIA
- The sets , paid on banks’ overnight money at the Bank of England. , the average overnight sterling borrowing rate, tracks it; and are the dollar and euro rates.
- Treasury bills
- Short government debt with no coupon, bought below 100 and repaid at 100. US bills are quoted as a discount on a 360-day year: a 180-day bill at 4% costs 98.00.
- Repo
- A loan secured on a bond: sell it for cash and agree to buy it back later at a slightly higher price. Desks finance bonds this way, so a bond yielding 4.5% financed at 4.0% earns 0.5% a year.
- General collateral and specials
- Most government bonds repo at the rate, close to Bank Rate. A bond many traders want to borrow trades , at a lower rate, so its owner borrows cash cheaply.
- Pricing the policy path
- SONIA futures quote 100 minus the expected rate (96.20 implies 3.80%), and price the rate after each meeting. Bank Rate at 4.00% with 3.90% priced after the next meeting is 10 of a 25bp cut: about a 40% chance.
The chance of a move the market has priced
Chance of a 25bp move ≈ (rate priced − Bank Rate now) ÷ 0.25
- rate priced
- rate implied for the period after the meeting, %
- 0.25
- the size of one move, in percentage points (25bp)
How it works
1. The central bank sets the overnight rate
The Bank of England’s sets : the interest the Bank pays commercial banks on money they leave with it overnight. No bank will lend overnight for much less than it can earn at the Bank, so short-term borrowing costs across the economy follow Bank Rate.
2. Bills: interest as a discount
A pays no coupon. You buy it below 100 and get 100 back, and the gap is your interest. US bills are quoted as a discount yield: price = 100 × (1 − rate × days ÷ 360). A 91-day bill at 4% costs 100 × (1 − 0.04 × 91 ÷ 360) = 98.99.
3. Repo: borrowing against a bond
A bank that owns a can raise cash by selling it and agreeing to buy it back tomorrow at a slightly higher price. That is a : a loan with the bond as security. Interest = cash × rate × days ÷ 365 in sterling, or ÷ 360 in dollars and euros.
4. Why every bond desk watches repo
Desks pay for most of the bonds they hold by borrowing in repo, so the repo rate is the cost of holding a bond. A bond yielding 4.5% financed at 4.0% earns 0.5% a year just for being held. If repo costs more than the bond yields, holding it costs money every day.
5. When one bond is in demand
Usually any government bond will do as security, at the rate, close to Bank Rate. But traders who want to sell a bond they don’t own must borrow it first. When many want the same bond, lenders of cash accept a lower rate to get it, and the bond trades . Its owner can then borrow cash cheaply.
6. Futures price the rate to come
is the average rate banks pay to borrow sterling overnight, and it tracks Bank Rate. A three-month SONIA future is quoted as 100 minus the average SONIA the market expects for that quarter. A price of 96.20 means the market expects 3.80%.
7. Reading the next meeting
work like those futures but for any period, including the weeks after each Bank of England meeting. If Bank Rate is 4.00% and swaps price 3.90% for the period after the next meeting, the market has priced 10bp of a possible 25bp cut: about a 40% chance.
8. Meeting by meeting
Line up the rates priced after each meeting and the steps between them are the moves priced at each one. With Bank Rate at 4.00% and 3.92% then 3.71% priced after the next two meetings, the market expects −8bp at the first and −21bp at the second: a cut by the second meeting is close to certain.
Worked example
Bank Rate is 4.00%. Overnight index swaps imply Bank Rate of 3.92% after the next meeting and 3.71% after the one after that.
- First meeting: 3.92 − 4.00 = −8bp.
- As a chance of a 25bp cut: 8 ÷ 25 = 32%.
- Second meeting: 3.71 − 3.92 = −21bp more.
- Total by the second meeting: −8 − 21 = −29bp, a little more than one full cut.
About a 32% chance of a cut at the next meeting, and about 29bp of cuts priced over the two meetings.
Check yourself
8 quick questions on the explanation above.
Practice
New numbers every set. Misses and guesses go into your review deck.
In the interview
Answer out loud in under a minute, then compare.
What’s repo, and why does every rates desk care about it?
How would you work out what the market expects from the next MPC meeting?
Why do funding rates sometimes spike at quarter-end?
Remember
Chance of a cut ≈ bp priced ÷ 25bp
Money-market prices show what traders expect the central bank to do, and repo is the cost of holding every bond.
Sources
Definitions and maths are standard textbook material; dated facts link to the sources above. Worked numbers are illustrative.