It has certainly been an interesting month or so for the cash management desk. At the end of February, expectations were that the Monetary Policy Committee (“MPC”) would cut rates at their next meeting, scheduled for 19th March. This would have brought the base rate down to 3.50% in the UK.
That was until 28th February, when the US joined forces with Israel and embarked on a war with Iran, aiming to bring about regime change in the country by targeting its nuclear and ballistic missile programmes with a series of strikes.
Iran’s retaliation – launching strikes of their own towards Israel and neighbouring countries and restricting access for ships passing through the Strait of Hormuz – has caused gas and oil prices to surge.
This energy price shock had a knock-on effect on long-term interest rates, quashing expectations of a rate cut by the MPC and prompting a pivot towards the possibility of two rate hikes this year. Additionally, there are growing concerns that the events unfolding in the Middle East could drive higher inflation in the UK, given its reliance on imported gas and oil, further increasing the cost of living.
Back in February, the MPC voted to hold the base rate at 3.75%. This was a tight vote of five to four, which could have gone either way. It therefore came as a surprise when the MPC unanimously voted to hold interest rates in March. This was further reinforced by the committee’s hawkish tone in the minutes, mentioning that it was “ready to act as necessary to ensure that CPI inflation remains on track to meet the 2% target in the medium term”, essentially signalling a readiness to increase interest rates if required. This was quite the shift from earlier market expectations of a potential rate cut this year.
Following this shift in stance from the MPC, markets immediately began pricing in up to four interest rate hikes of 0.25% over the year. This resulted in banks issuing certificates of deposit and fixed deposits 4.75% on one-year terms, a stark increase from the 3.8% levels that were being issued towards the end of February before the conflict began.
The Bank of England’s Governor, Andrew Bailey, subsequently emphasised that markets were getting ahead of themselves. He urged caution in drawing strong conclusions about the pace of any potential rate increases and reiterated that, currently, holding interest rates remains the most appropriate course.
We expect the MPC to hold interest rates this month, however, if the conflict persists, there is potential for official interest rates in the UK to rise, particularly if oil prices remain elevated. The MPC may also take the view that markets have already done some of the work for it over the past month, with higher deposit and certificate of deposit rates being issued during periods of heightened tension and so elevated oil prices. Conversely, when more positive developments have emerged and oil prices have fallen, these rates have also eased.
At the time of writing, a ceasefire between the US, Israel and Iran was announced on 7th April. Oil prices fell following news and market rates started to steadily ease from the highs seen in March. While the ceasefire appeared to be heading in the right direction, recent developments suggest progress has stalled. Peace talks over the weekend were unsuccessful and with the US now imposing a blockade on Iranian ports, the region remains far from stability.
For us on the cash management desk, we have adopted a more cautious approach to the long end of the yield curve, which has steepened significantly during this period of turmoil. Our focus has been on return of capital rather than return on capital. By maintaining higher allocations in high-interest call accounts and overnight deposits, we have remained well positioned to take advantage of opportunities as they arise. Where appropriate, we have selectively invested in certificates of deposit from respected, well-rated banks and government debt in the way of UK Treasury Bills.
