Liquidity lowdown: What does the Bank of England rate cut mean for money market funds?

The UK economy is in a bit of a precarious position. Since the Labour Party’s return to power in July 2024, their main mandate has been one of growth.

Their aim to achieve this, is by implementing new spending rules to restore financial stability and confidence and undertake infrastructure projects in the hope this brings new jobs and economic prosperity. However, right now, the UK is suffering from a distinct lack of growth having only grown 0.1% in November 2024, with December’s figures due on February 13th. Inflation remains elevated with Consumer Price Index (CPI) year-on-year at 2.60% which is clearly still a concern to the Bank of England (BoE) and potentially creates a rather unusual and pretty uncommon stagflation environment. However, the CPI is a measure of inflation that is backward-looking, and we have seen gradual improvements in inflation data over the past couple of months, with core CPI having eased by 0.3% in January 2025, and services CPI following a similar pattern. Any recent increases in CPI have largely been explained by significant base effects, which have dragged the yearly figure upwards. Nonetheless, the BoE delivered a 25bps cut in interest rates at its February meeting, despite concerns over sticky inflation.

Money Market Funds (MMFs) were well prepared a rate cut, and since the middle of January 2025, this has been fully priced in by the market. However, this has not necessarily meant that yields on certificate of deposits (CDs) have followed suit. Spreads have been tapering for some time now and compared to historic averages over the past 10 years, we are some way from the highs. One-year CDs are currently yielding around 4.50%, down around 20bps from the start of the year, with six-month CDs averaging around 4.55%. This is making other money market assets, such as treasury bills, look increasingly attractive as they are achieving similar yields but without the associated credit risk of investing in CDs. In addition, they provide much sought-after liquidity for MMFs. After any rate cut, markets tend to look for any forward guidance from the BoE in an effort to understand the likelihood and timing of future rate cuts this year. The next cut is currently priced in for May 2025, which means MMFs will have to contend with the possibility of lower yields in the months to come.

MMFs will have to contend with the possibility of lower yields in the months to come.

Increasing the duration of an MMF helps to delay the reinvestment risk that frequently occurs in these funds, as maturing assets are reinvested at lower yields. Due to the current trajectory of interest rates, the highest yielding assets in a MMF were, until the BoE cut interest rates, those that currently mature within one day, which yield around SONIA (Sterling Overnight Index Average). However, the rate cut delivered on February 6 meant that the yield on those assets fell immediately, in line with SONIA. Investing in assets with a longer duration extends the time that the MMF can benefit from that elevated yield within the fund, mitigating some of the impacts associated with lower rates. Whilst MMFs can expect lower returns throughout the BoE’s rate cutting cycle, their yield on a risk-adjusted basis should remain appealing to many investors.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.