(Bloomberg) -- Bank of England officials are downplaying an abnormal paralysis in the UK’s most important market interest rate, saying it remains efficient in reflecting what’s happening in markets.
The Sterling Overnight Index Average, or SONIA, has stayed at exactly five basis points below the BOE’s rate since May 7 — or 70 business days. The previous record in data going back to 1997 was just four sessions.
“Flatlining of the SONIA rate for a prolonged period is unprecedented,” said BOE officials in a blog Wednesday. “Since the rate continues to reflect what is happening in the market — a change in behavior in the market affecting the shape of the distribution of rates – it is not necessarily cause for concern.”
SONIA, which is referenced in over £90 trillion ($116 trillion) of new transactions a year, represents the average interest rate at which UK banks borrow sterling overnight from other financial institutions. It’s a key tool in the BOE’s monetary policy transmission because it is used to price financial contracts ranging from derivatives to mortgages.
The BOE’s policy of shrinking bond holdings and draining liquidity pushed the cost of borrowing in markets higher, which was reflected by SONIA converging with the BOE rate. As the steadiness in the rate continues into a fourth month, the BOE researchers said the current state of affairs might end soon.
“The backdrop of liquidity draining means SONIA could resume its upwards drift at some point,” wrote Joanna McLafferty, Kirstine McMillan and Joseph Smart, who work in the BOE’s sterling markets division. “Banks may have to compete more for overnight funding and lenders may be able to demand a better return on their deposits.”
Traders say SONIA’s five basis point discount reflects the minimum amount banks are willing to accept in order to take on deposits. The BOE officials said the impasse could reflect “stickiness” as “banks seek to resist an erosion of margin earned” by taking in cash.
Still, they said the market is continuing to function and SONIA is “reflecting the market.” The efficacy of such rates has been in the spotlight since SONIA replaced sterling Libor as the main benchmark following a global rate-rigging scandal.
That makes justifying the unusual activity a priority for the BOE, with the officials writing that the “robustness of SONIA is paramount.” Their blog echoed a footnote to a speech last month by Vicky Saporta, the BOE’s executive director for markets, which said “SONIA remaining the same isn’t necessarily concerning.”
SONIA is calculated by the BOE compiling data from banks and then reporting the “trimmed mean” to four decimal places daily at 9 a.m. London time. This number is based on the central 50% of the volume-weighted distribution of rates. It read 5.2000% from May 7 to July 31, before moving a quarter-percentage point lower on Aug. 1 to 4.9500% in lockstep with the BOE cutting its key rate.
Despite the recent streak of steady readings, the underlying data suggests the market isn’t entirely moribund. While the 25th and 75th percentile of SONIA contributions are the same, the 10th and 90th percentiles remain five basis points apart from each other.
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