Understanding SONIA Outlook and Hedge Strategy
Published on: 28th February 2023
The sterling overnight index average, also known as SONIA, is the effective overnight interest rate that banks pay for unsecure trades in the British sterling market. As a benchmark interest rate for short-term financial transactions, it offers traders and financial organisations a substitute for the London Interbank Offered Rate, or LIBOR.
SONIA Forecast: A Cautious Approach to Further Rate Hikes
The current outlook for SONIA interest rates in the UK suggests that while inflation has peaked, it remains in double digits. As a result, the Bank of England has cautiously increased rates by 50 bps in its latest meeting, bringing the rate to 4% in February 2023 from 0.75% in May 2022. While further rate hikes may be necessary if persistent inflationary pressures are observed, it is unlikely that they will be aggressive.
SONIA Hedge Strategy: Prudent Approach for Longer Tenors
The above forecast suggests that it may not make sense for companies to aggressively hedge their exposure to SONIA interest rates. However, a SONIA hedge strategy could still be prudent, particularly for longer tenors where hedge rates are lower. One option could be to use an IRS to hedge a portion of the exposure, such as 40%, and leave the remaining 60% unhedged to benefit from potential rate declines.
Analyzing the SONIA Rate Chart and Curve
When considering the SONIA rate chart, it’s important to note that the Sonia 3-month rate and the SONIA 1-month rate have both increased since the peak in October 2022, but have since moderated to 10.1%. The SONIA rate curve may indicate a need for continued monitoring of inflationary pressures, as the Bank of England has suggested in its latest statement.