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Why SONIA Can Trade Below the Bank of England Base Rate

Article Quant Q&A · Author: nsivakr
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Summary

The document explains why the SONIA overnight rate can be below the UK Bank Rate. The Bank Rate is the rate banks receive on deposits held at the Bank of England, while SONIA reflects actual overnight lending transactions among a broader set of institutions, including non-bank financial firms. Because those firms cannot necessarily access the Bank of England deposit rate directly, the two rates need not match.

The answer attributes downward pressure on SONIA in the described market setting to abundant cash reserves: institutions with excess cash compete to place it in overnight markets. The document gives a conceptual explanation rather than a general quantitative relationship or a time series of rate spreads. The direction and size of the difference may depend on market conditions and institutional access, so the stated explanation should be read in the context described rather than as a rule that SONIA is always lower.

Key ideas

  • Bank Rate is the return banks receive on deposits at the Bank of England.
  • SONIA is based on observed overnight lending transactions across a wider set of institutions.
  • Non-bank institutions may not have access to the Bank of England deposit rate available to banks.
  • Abundant cash can push overnight transaction rates lower as institutions seek places to invest it.

Tags

Fixed incomeMarket microstructure
Full text
# Why is SONIO Index lower than UK Rates?


# Why is SONIO Index lower than UK Rates?












The current UK Rate is 3.5. However, SONIO index is at 3.4269. What is the reason for SONIO Index being lower than UK Rates?

## Answer by dm63 (score 5, accepted)

https://quant.stackexchange.com/a/74116

The current UK Base Rate is 3.50%, which is what UK banks earn on their deposits at the Bank of England. That rate is fixed by the BoE. Sonia on the other hand is determined by actual transactions in overnight lending by a variety of institutions including non bank financial institutions. Because there is currently a lot of cash in the system (excess reserves), there is downward pressure on Sonia as institutions try to invest cash. The point is that these institutions cannot get the 3.5% from the BoE because they are not banks.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.