Treasury Management Strategy 2024 to 2025

2.1. The council employs professionally qualified and experienced staff with responsibility for making borrowing and investment decisions. Officers are supported by external advisers who are specialists in their fields.

The council currently employs Arlingclose Limited as treasury management advisers.

2.2. This approach ensures that the council has access to a wide pool of relevant market intelligence, knowledge and skills, that would be very difficult and costly to replicate internally.

However, whilst advisers provide support to the internal treasury function, final decisions on treasury matters always remain with the council.

3.1. Treasury management decisions made by the council must take into consideration external factors, particularly the wider economic backdrop and the outlook for financial markets and interest rates.

3.2. The major external influences on the council’s treasury management activity in 2024/25 are expected to be the ongoing impact from the war in Ukraine and the Middle East, continuing high levels of inflation, higher interest rates, a challenging economic outlook and an uncertain political climate due to an upcoming UK general election and American presidential election.

 

 

4.1. Each of Dorset Council’s six predecessor councils had different balance sheets and
different capital programmes, and each had therefore developed different treasury
management strategies to suit their individual circumstances.

Dorset Council continues to develop its own strategy to meet the needs of its combined balance sheet and capital programme. Existing borrowing and investment positions will continue to be reviewed to achieve an appropriate balance between cost and risk.

4.2. The council’s balance sheet summary and forecast are shown in the table below.

Table, Balance Sheet summary in £ millions

n/a	31-Mar 2023 Actual	31-Mar 2024 Forecast	31-Mar 2025 Budget	31-Mar 2026 Budget	31-Mar 2027 Budget
Capital Financing Requirement (CFR)	367	388	482	543	567
Less: PFI and other debt liabilities	21	20	19	18	17
Loans CFR (underlying borrowing requirement)	346	368	463	525	550
Less: External borrowing	198	230	313	374	398
Internal Borrowing	148	138	150	151	152
Less: Balance sheet resources	263	250	240	230	220
Cash and Investments	115	112	90	79	68

4.3. The underlying need to borrow for capital purposes is measured by the Capital
Financing Requirement (CFR), while balance sheet resources are the underlying sums
available for investment.

The council’s current strategy is to maintain borrowing and investments below their underlying levels, sometimes known as internal borrowing.

The council has an increasing CFR due to the capital programme.

4.4. CIPFA’s Prudential Code for Capital Finance in Local Authorities recommends that the
council’s total debt should be lower than its highest forecast CFR over the next three
years. Table 1 shows that the council expects to comply with this recommendation
over the medium term.

4.5. To compare the council’s actual borrowing against an alternative strategy, a “liability
benchmark” has been calculated showing the lowest risk level of borrowing. This
assumes the same forecasts as table 1 above, but that cash and investment balances
are kept to a minimum level of £30m at each year-end to maintain sufficient liquidity
but minimise credit risk.

4.6. The liability benchmark is an important tool to help establish whether the council is
likely to be a long-term borrower or long-term investor in the future, and so shape its
strategic focus and decision making.

The liability benchmark itself represents an estimate of the cumulative amount of external borrowing the council must hold to fund its current capital and revenue plans while keeping treasury investments at the minimum level required to manage day-to-day cash flow.

Table, Prudential Indicator: Liability benchmark

n/a	31 March 2023 Actual £m	31 March 2024 Forecast £m	31 March 2025 Budget £m	31 March 2026 Budget £m	31 March 2027 Budget £m
Loans CFR (underlying borrowing requirement)	346	368	463	525	550
Less: Balance sheet resources	263	250	240	230	220
Net loans/borrowing requirement	83	118	223	295	330
Plus: Liquidity allowance	30	30	30	30	30
Liability Benchmark	113	148	253	325	360

4.7. Further to the medium-term forecasts in the table above, the data from the long-term liability benchmark based on the proposed capital programme together with the maturity profile of the council’s existing borrowing tells us the following. 

4.8. The data indicates that the council will need additional external borrowing over the
next ten years or so and thereafter existing borrowing will be above the liability
benchmark but remains below the capital financing requirement.

This is something which the council monitors and engages with external treasury management advisors to monitor and review as part of setting and implementing the treasury management strategy.

5.1. As at 31 January 2024, the council held £195 million of loans as part of its strategy for
funding current and previous years’ capital programmes. External borrowing as at 31
January 2024 is summarised in Table 3 below.

Table, External borrowing (as at 31 January 2024)

n/a	Balance £m	Average Rate %	Average Maturity (years)
Public Works Loan Board	61.8	4.1	21.1
Banks (fixed-term)	25.6	4.7	54.6
Banks (LOBO)	11.0	4.6	54.0
Local authorities (long-term)	15.0	4.4	37.0
Local authorities (short-term)	37.0	5.5	0.6
Other lenders (fixed-term)	45.0	3.9	43.9
Total External Borrowing	195.4	4.5	20.9

5.2. The council’s chief objective when borrowing money has been to strike an
appropriately low risk balance between securing low interest costs and achieving
certainty of those costs over the period for which funds are required.

The flexibility to renegotiate loans should the council’s long-term plans change is a  secondary objective.

5.3. The council’s borrowing strategy continues to address the key issue of affordability
without compromising the longer-term stability of the debt portfolio.

With interest rates on borrowing high relative to returns on investments it is still likely to be more cost effective to use internal resources rather than external borrowing where possible.

This strategy has enabled the council to reduce net borrowing costs (despite foregone
investment income) and to reduce overall treasury risk.

5.6. The council may also consider forward starting loans, where the interest rate is fixed
in advance, but the cash is received in later years.

This would enable certainty of cost to be achieved without suffering a cost of carry in the intervening period. In addition, the council may borrow short-term loans to cover unplanned cash flow shortages.

5.7. The council’s approved sources of long-term and short-term borrowing are:

• HM Treasury’s PWLB lending facility (formerly the Public Works Loan Board)and any successor body
• UK Infrastructure Bank Ltd
• any institution approved for investments (see below)
• any other bank or building society authorised to operate in the UK
• any other UK public sector body
• UK public and private sector pension funds (including the Dorset County Pension Fund) 
• retail investors via a regulated peer-to-peer platform
• capital market bond investors
• UK Municipal Bonds Agency plc and other special purpose companies created to enable local council bond issues

5.8. In addition, capital finance may be raised by the following methods that are not borrowing, but may be classed as other debt liabilities:

• leasing
• hire purchase
• Private Finance Initiative (PFI)
• sale and leaseback
• similar asset based finance

5.9. UK Municipal Bonds Agency plc was established in 2014 by the Local Government Association as an alternative to the PWLB.

It issues bonds on the capital markets and lends the proceeds to local authorities.

This is a more complicated source of finance than the PWLB for two reasons: borrowing authorities will be required to provide bond investors with a guarantee to refund their investment in the event that the agency is unable to for any reason; and there will be a lead time of several months between committing to borrow and knowing the interest rate payable.

Any decision to borrow from the Agency will therefore be the subject of a separate report.

5.10. The council holds one Lender’s Option Borrower’s Option (LOBO) loan for £11m where the lender has the option to propose an increase in the interest rate at set dates, following which the council has the option to either accept the new rate or to repay the loan at no additional cost.

5.11. Short-term and variable rate loans leave the council exposed to the risk of short-term interest rate rises and are therefore subject to the interest rate exposure limits in the treasury management indicators below.

5.12. The PWLB allows authorities to repay loans before maturity and either pay a premium or receive a discount according to a set formula based on current interest rates. Other lenders may also be prepared to negotiate premature redemption terms.

The council may take advantage of this and replace some loans with new loans, or repay loans without replacement, where this is expected to lead to an overall cost saving or a reduction in risk.

The recent rise in interest rates means that more favourable debt rescheduling  opportunities should arise than in previous years.

5.13. Where the council finances capital expenditure by debt, it must put aside resources to repay that debt in later years.

The amount charged to the revenue budget for the repayment of debt is known as Minimum Revenue Provision (MRP) and is calculated with regard to statutory guidance.

The guidance requires the council to approve an Annual MRP Statement each year, and this is included as Annex 2 to this Treasury Management Strategy.

6.1. The council holds significant levels invested funds, representing income received in
advance of expenditure plus balances and reserves held. Cash, cash equivalents and
investments held on 31 December 2023 are summarised in the table below.

Table, Cash and Treasury Investments (as at 31 December 2023)

n/a	Balance £m
Cash and Cash Equivalents	26.2
Treasury Investments	n/a
Corporate bond funds	12.9
Equity income funds	33.0
Property funds	19.6
Multi asset income funds	5.1
Total Treasury Investments	70.5
Total Cash and Investments	96.7

6.2. The CIPFA Code requires the council to invest its treasury funds prudently, and to
have regard to the security and liquidity of its investments before seeking the highest
rate of return, or yield.

The council’s objective when investing money is to strike an appropriate balance between risk and return, minimising the risk of incurring losses from defaults and the risk of receiving unsuitably low investment income.

Where balances are expected to be invested for more than one year, the council will aim to
achieve a total return that is equal or higher than the prevailing rate of inflation, in order
to maintain the spending power of the sum invested.

The council aims to be a responsible investor and will endeavour to consider  environmental, social and governance (ESG) issues when making investment decisions.

6.3. As demonstrated by the liability benchmark above, the council expects to be a long-term borrower and new treasury investments will therefore be made primarily to
manage day-to-day cash flows using short-term low risk instruments.

6.4. The council has investments of approximately £70m in externally managed strategic
pooled investment vehicles (bond, equity, multi-asset and property funds) where short-term
security and liquidity are lesser considerations, and the objectives instead are regular revenue income and long-term price stability.

6.5. Under the IFRS 9 standard, the accounting for certain investments depends on the
council’s “business model” for managing them.

The council aims to achieve value from its treasury investments by a business model of collecting the contractual cash flows and therefore, where other criteria are also met, these investments will continue to be accounted for at amortised cost.

6.6. The CIPFA Code does not permit local authorities to both borrow and invest long-term
for cash flow management.

But the council may make long-term investments for treasury risk management purposes, including to manage interest rate risk by investing sums borrowed in advance for the capital programme for up to three years; to manage inflation risk by investing usable reserves in instruments whose value rises with inflation; and to manage price risk by adding diversification to the strategic pooled fund portfolio.

6.7. Environmental, social and governance (ESG) considerations are increasingly a factor in global investors’ decision making, but the framework for evaluating investment opportunities is still developing and therefore it is not currently feasible to consistently and reliably formally consider ESG scoring or other real-time ESG criteria at an individual investment level.

When investing in banks and funds, the council will prioritise banks that are signatories to the UN Principles for Responsible Banking and funds operated by managers that are signatories to the UN Principles for Responsible Investment, the Net Zero Asset Managers Alliance and/or the UK Stewardship Code.

6.8. The council may invest its surplus funds with any of the counterparty types in table 5 below, subject to the limits shown.

Table, Treasury investment counterparties and limits

Sector	Time limit	Counterparty limit	Sector limit
The UK Government	50 years	Unlimited	n/a
Local authorities & other government entities	25 years	£30m	Unlimited
Secured investments	25 years	£30m	Unlimited
Banks (unsecured)	13 months	£15m	Unlimited
Building societies (unsecured)	13 months	£15m	£30m
Registered providers (unsecured)	5 years	£15m	£30m
Money market funds	n/a	£30m	Unlimited
Strategic pooled funds	n/a	£20m	£150m
Real estate investment trusts	n/a	£20m	£100m
Other investments	5 years	£15m	£30m

The above table must be read in conjunction with the notes below, the notes give a more detailed explanation of some of the various sectors and limits. 

6.9. *Minimum credit rating: Treasury investments in the sectors marked with an asterisk will only be made with entities whose lowest published long-term credit rating is no lower than A-. Where available, the credit rating relevant to the specific investment or class of investment is used, otherwise the counterparty credit rating is used.

However, investment decisions are never made solely based on credit ratings, and all other relevant factors including external advice will be taken into account. For entities without published credit ratings, investments may be made where external advice indicates the entity to be of similar credit quality.

6.10. Government: Loans to, and bonds and bills issued or guaranteed by, national governments, regional and local authorities and multilateral development banks.

These investments are not subject to bail-in, and there is generally a lower risk of insolvency, although they are not zero risk. Investments with the UK Government are deemed to be zero credit risk due to its ability to create additional currency and therefore may be made in unlimited amounts for up to 50 years.

6.11. Secured investments: Investments secured on the borrower’s assets, which limits the potential losses in the event of insolvency.

The amount and quality of the security will be a key factor in the investment decision. Covered bonds and reverse repurchase agreements with banks and building societies are exempt from bail-in.

Where there is no investment specific credit rating, but the collateral upon which the investment is secured has a credit rating, the higher of the collateral credit rating and the counterparty credit rating will be used.

The combined secured and unsecured investments with any one counterparty will not exceed the cash limit for secured investments.

6.12. Banks and building societies (unsecured): Accounts, deposits, certificates of deposit and senior unsecured bonds with banks and building societies, other than multilateral development banks. These investments are subject to the risk of credit loss via a bail-in should the regulator determine that the bank is failing or likely to fail. See below for arrangements relating to operational bank accounts.

6.13. Registered providers (unsecured): Loans to, and bonds issued or guaranteed by, registered providers of social housing or registered social landlords, formerly known as housing associations.

These bodies are regulated by the Regulator of Social Housing (in England), the Scottish Housing Regulator, the Welsh Government and the Department for Communities (in Northern Ireland).

As providers of public services, they retain the likelihood of receiving government support if needed.

6.14. Money market funds: Pooled funds that offer same-day or short notice liquidity and very low or no price volatility by investing in short-term money markets.

They have the advantage over bank accounts of providing wide diversification of investment risks, coupled with the services of a professional fund manager in return for a small fee.

Although no sector limit applies to money market funds, the council will take care to diversify its liquid investments over a variety of providers to ensure access to cash at all times.

6.15. Strategic pooled funds: Bond, equity and property funds that offer enhanced returns over the longer term but are more volatile in the short term.

These allow the council to diversify into asset classes other than cash without the need to own and manage the underlying investments.

Because these funds have no defined maturity date, but are available for withdrawal after a notice period, their performance and continued suitability in meeting the council’s investment objectives will be monitored regularly.

6.16. Real estate investment trusts: Shares in companies that invest mainly in real estate and pay the majority of their rental income to investors in a similar manner to pooled property funds.

As with property funds, REITs offer enhanced returns over the longer term, but are more volatile especially as the share price reflects changing demand for the shares as well as changes in the value of the underlying properties.

6.17. Other investments: This category covers treasury investments not listed above, for example unsecured corporate bonds and company loans.

Non-bank companies cannot be bailed-in but can become insolvent placing the council’s investment at risk.

6.18. Operational bank accounts: The council may incur operational exposures, for example though current accounts, collection accounts and merchant acquiring services, to any UK bank with credit ratings no lower than BBB- and with assets greater than £25 billion.

These are not classed as investments but are still subject to the risk of a bank bail-in, and balances will therefore be kept below £10m per bank.

The Bank of England has stated that in the event of failure, banks with assets greater than £25 billion are more likely to be bailed-in than made insolvent, increasing the chance of the council maintaining operational continuity.

6.19. Risk assessment and credit ratings: Credit ratings are obtained and monitored by the council’s treasury advisers, who will notify changes in ratings as they occur.

The credit rating agencies in current use are listed in the Treasury Management Practices document.

Where an entity has its credit rating downgraded so that it fails to meet the approved investment criteria then:

• no new investments will be made
• any existing investments that can be recalled or sold at no cost will be, and
• full consideration will be given to the recall or sale of all other existing investments with the affected counterparty

6.20. Where a credit rating agency announces that a credit rating is on review for possible downgrade (also known as “negative watch”) so that it may fall below the approved rating criteria, then only investments that can be withdrawn on the next working day will be made with that organisation until the outcome of the review is announced.

This policy will not apply to negative outlooks, which indicate a long-term direction of travel rather than an imminent change of rating.

6.21. Other information on the security of investments: The council understands that credit ratings are good, but not perfect, predictors of investment default.

Full regard will therefore be given to other available information on the credit quality of the organisations in which it invests, including credit default swap prices, financial statements, information on potential government support, reports in the quality financial press and analysis and advice from the council’s treasury management adviser.

No investments will be made with an organisation if there are substantive doubts about its credit quality, even though it may otherwise meet the above criteria.

6.22. Reputational aspects: The council is aware that investment with certain counterparties, while considered secure from a purely financial perspective, may leave it open to criticism, valid or otherwise, that may affect its public reputation, and this risk will therefore be considered when making investment decisions.

6.23. Market conditions: When deteriorating financial market conditions affect the creditworthiness of all organisations, as happened in 2008, 2020 and 2022, this is not generally reflected in credit ratings, but can be seen in other market measures.

In these circumstances, the council will restrict its investments to those organisations of higher credit quality and reduce the maximum duration of its investments to maintain the required level of security.

The extent of these restrictions will be in line with prevailing financial market conditions. If these restrictions mean that insufficient commercial organisations of high credit quality are available to invest the council’s cash balances, then the surplus will be deposited with the UK Government, or with other local authorities.

This will cause investment returns to fall but will protect the principal sum invested.

6.24. Investment limits: the maximum that will be lent to any one organisation (other than the UK Government) will be £30 million.

A group of entities under the same ownership will be treated as a single organisation for limit purposes.

Credit risk exposures arising from non-treasury investments, financial derivatives and balances greater than £10 million in operational bank accounts count against the relevant investment limits.

6.25. Limits are also placed on fund managers, investments in brokers’ nominee accounts and foreign countries and industry sectors as below.

Investments in pooled funds and multilateral development banks do not count against the limit for any single foreign country, since the risk is diversified over many countries.

Table, Additional investment limits

Investment	Cash limit
Any group of pooled funds under the same management	£50m per manager
Negotiable instruments held in a broker’s nominee account	£50m per broker
Foreign countries	£25m per country

6.26. Liquidity management: The council monitors its cash flow forecasting on a daily basis to determine the maximum period for which funds may prudently be committed.

The forecast is compiled on a prudent basis to minimise the risk of the council being forced to borrow on unfavourable terms to meet its financial commitments.

Limits on long-term investments are set by reference to the council’s medium-term financial plan and cash flow forecast.

The council will spread its liquid cash over at least three providers (e.g. bank accounts and money market funds) to ensure that access to cash is maintained in the event of operational difficulties at any one provider.

7.1. The council measures and manages its exposures to treasury management risks using the following indicators.

7.2. Security: The council has adopted a voluntary measure of its exposure to credit risk by monitoring the value-weighted average credit score of its investment portfolio.

Arlingclose calculate the credit score by applying a score to each investment (AAA=1, AA+=2, etc.) and taking the average, weighted by the size of each investment. Unrated investments are assigned a score based on their perceived risk.

7.3. The target for the portfolio average credit score is 6.0.

7.4. Liquidity: The council has adopted a voluntary measure of its exposure to liquidity
risk by monitoring the amount of cash available to meet unexpected payments within
a rolling three-month period, without additional borrowing.

7.5. The target level of cash available within three months is £30m. In addition, the council
aims to hold a minimum of £10m readily available in same day access bank accounts
and/or Money Market Funds.

7.6. Maturity structure of borrowing: This indicator is set to control the council’s
exposure to refinancing risk.

The upper and lower limits on the maturity structure of borrowing are in the following table.

Table, Maturity Structure of Borrowing

n/a	Upper limit	Lower limit
Under 12 months	30%	0%
12 Months to 2 Years	30%	0%
2 Years to 5 Years	30%	0%
5 Years to 10 Years	35%	0%
10 Years to 20 Years	35%	0%
20 Years to 30 Years	45%	0%
30 Years to 40 Years	45%	0%
40 Years to 50 Years	45%	0%
50 Years and above	50%	0%

7.7. Time periods start on the first day of each financial year. The maturity date of borrowing is the earliest date on which the lender can demand repayment.

7.8. Long-term treasury management investments: The purpose of this indicator is to
control the council’s exposure to the risk of incurring losses by seeking early
repayment of its investments.

The prudential limits on long-term treasury management investments are in the following table.

Table, Investments beyond year end

n/a	2024/25	2025/26	2026/27	No fixed date
Limit on principal invested beyond year end	£30m	£20m	£20m	£100m

7.9. Long-term investments with no fixed maturity date include strategic pooled funds and
real estate investment trusts but exclude money market funds and bank accounts with
no fixed maturity date as these are considered short-term.

 

8.1. Local authorities have previously made use of financial derivatives embedded into
loans and investments both to reduce interest rate risk (e.g. interest rate collars and
forward deals) and to reduce costs or increase income at the expense of greater risk (e.g. LOBO loans and callable deposits). The general power of competence in section 1 of the Localism Act 2011 removes much of the uncertainty over local authorities’ use of standalone financial derivatives (i.e. those that are not embedded into a loan or investment).

8.2. The council will only use standalone financial derivatives (such as swaps, forwards, futures and options) where they can be clearly demonstrated to reduce the overall level of the financial risks that the council is exposed to.

Additional risks presented, such as credit exposure to derivative counterparties, will be taken into account when determining the overall level of risk.

Embedded derivatives, including those present in pooled funds and forward starting transactions, will not be subject to this policy, although the risks they present will be managed in line with the overall treasury risk management strategy.

8.3. Financial derivative transactions may be arranged with any organisation that meets the approved investment criteria, assessed using the appropriate credit rating for derivative exposures.

An allowance for credit risk calculated using the methodology in the Treasury Management Practices document will count against the counterparty credit limit and the relevant foreign country limit.

8.4. In line with the CIPFA Code, the council will seek external advice and will consider that advice before entering into financial derivatives to ensure that it fully understands the implications.

9.1. The council has opted up to professional client status with its providers of financial services, including advisers, banks, brokers and fund managers, allowing it access to a greater range of services but without the greater regulatory protections afforded to individuals and small companies.

Given the size and range of the council’s treasury management activities, the Section 151 Officer believes this to be the most appropriate status.

10.1. The CIPFA Code does not prescribe any particular treasury management strategy for local authorities to adopt.

The Section 151 Officer believes that the above strategy represents an appropriate balance between risk management and cost effectiveness. Some alternative strategies, with their financial and risk management implications, are listed below.

Alternative

Invest in a narrower range of counterparties and/or for shorter times

Impact on income and expenditure

Interest income will be lower

Impact on risk management

Lower chance of losses from credit related defaults, but any such losses may be greater.

Alternative

Invest in a wider range of counterparties and/or for longer times

Impact on income and expenditure

Interest income will be higher

Impact on risk management

Increased risk of losses from credit related defaults, but any such losses may be smaller

Alternative

Borrow additional sums at long-term fixed interest rates

Impact on income and expenditure

Debt interest costs will rise; this is unlikely to be offset by higher investment income

Impact on risk management

Higher investment balance leading to a higher impact in the event of a default; however long-term interest costs may be more certain

Alternative

Borrow short-term or variable loans instead of long-term fixed rates

Impact on income and expenditure

Debt interest costs will initially be lower

Impact on risk management

Increases in debt interest costs will be broadly offset by rising investment income in the medium term, but long-term costs may be less certain

Alternative

Reduce level of borrowing

Impact on income and expenditure

Saving on debt interest is likely to exceed lost investment income

Impact on risk management

Reduced investment balance leading to a lower impact in the event of a default; however long-term interest costs may be less certain

Service Investments

11.1 The council may make investments to assist local public services, including making loans to or investing in local service providers, including its own subsidiaries to support local public services and stimulate local economic growth. Service investments can make a commercial return but obtaining those returns will not be the primary purpose of the investment.

11.2 The main risk when making service loans is that the borrower will be unable to repay the principal lent and/or the interest due.

The council makes every reasonable effort to collect the full sum lent and has appropriate credit control arrangements in place to recover overdue repayments and assesses the risk of loss before entering into and whilst holding service loans.

11.3 The council may invest in the shares of its subsidiaries, its suppliers, and local businesses to support local public services and stimulate local economic growth.

One of the risks of investing in shares is that they fall in value meaning that the initial outlay may not be recovered and the council assesses the risk of loss before entering into and whilst holding shares.

11.4 The value and risks of service investments must remain proportionate to the size of the council.

As at 31 March 2023, the council held service loans to town and parish councils, local charities and other organisations totalling £3.0m and shares in subsidiaries valued at £33,000.

Commercial Investments

12.1. Investments for commercial purposes (or commercial investments) are taken or held primarily for financial return (or yield) and are not linked to treasury management activity or to delivering services.

12.2. Local authorities must not borrow to invest for the primary purpose of financial return and PWLB loans are no longer available to local authorities if they plan to buy investments primarily for yield in the next three years.

12.3. The council has no commercial investments and intends to avoid this activity in order to retain its access to PWLB loans.

Economic background

The impact on the UK from higher interest rates and inflation, a weakening economic outlook, an uncertain political climate due to an upcoming general election, together with war in Ukraine and the Middle East, will be major influences on the Authority’s treasury management strategy for 2024/25.

The Bank of England (BoE) increased Bank Rate to 5.25% in August 2023, before maintaining this level for the rest of 2023. In December 2023, members of the BoE’s Monetary Policy Committee voted 6-3 in favour of keeping Bank Rate at 5.25%. The three dissenters wanted to increase rates by another 0.25%.

The November quarterly Monetary Policy Report (MPR) forecast a prolonged period of weak Gross Domestic Product (GDP) growth with the potential for a mild contraction due to ongoing weak economic activity.

The outlook for CPI inflation was deemed to be highly uncertain, with upside risks to CPI falling to the 2% target coming from potential energy price increases, strong domestic wage growth and persistence in price-setting.

Office for National Statistics (ONS) figures showed CPI inflation was 3.9% in November 2023, down from a 4.6% rate in the previous month and, in line with the recent trend, lower than expected.

The core CPI inflation rate declined to 5.1% from the previous month’s 5.7%, again lower than predictions.

Looking ahead, using the interest rate path implied by financial markets the BoE expects CPI inflation to continue falling slowly, but taking until early 2025 to reach the 2% target before dropping below target during the second half 2025 and into 2026.

ONS figures showed the UK economy contracted by 0.1% between July and September 2023.

The BoE forecasts GDP will likely stagnate through 2024.

The BoE forecasts that higher interest rates will constrain GDP growth, which will remain weak over the entire forecast horizon.

The labour market appears to be loosening, but only very slowly.

The unemployment rate rose slightly to 4.2% between June and August 2023, from 4.0% in the previous 3-month period, but the lack of consistency in the data between the two periods made comparisons difficult.

Earnings growth has remained strong, but has showed some signs of easing; regular pay (excluding bonuses) was up 7.3% over the period and total pay (including bonuses) up 7.2%.

Adjusted for inflation, regular pay was 1.4% and total pay 1.3%. Looking forward, the MPR showed the unemployment rate is expected to be around 4.25% in the second half of calendar 2023, but then rising steadily over the forecast horizon to around 5% in late 2025/early 2026.

Credit outlook

Credit Default Swap (CDS) prices were volatile during 2023, spiking in March on the back of banking sector contagion concerns following the major events of Silicon Valley Bank becoming insolvent and the takeover of Credit Suisse by UBS.

After then falling back in Q2 of calendar 2023, in the second half of the year, higher interest rates and inflation, the ongoing war in Ukraine, and now the Middle East, have led to CDS prices increasing steadily.

On an annual basis, CDS price volatility has so far been lower in 2023 compared to 2022, but this year has seen more of a divergence in prices between ringfenced (retail) and non-ringfenced (investment) banking entities once again.

Moody’s revised its outlook on the UK sovereign to stable from negative to reflect its view of restored political predictability following the volatility after the 2022 mini-budget.

Moody’s also affirmed the Aa3 rating in recognition of the UK’s economic resilience and strong institutional framework.

Following its rating action on the UK sovereign, Moody’s revised the outlook on five UK banks to stable from negative and then followed this by the same action on five rated local authorities. However, within the same update the long-term ratings of those five local authorities were downgraded.

There remain competing tensions in the banking sector, on one side from higher interest rates boosting net income and profitability against another of a weakening economic outlook and likely recessions that increase the possibility of a deterioration in the quality of banks’ assets.

However, the institutions on our adviser Arlingclose’s counterparty list remain well-capitalised and their counterparty advice on both recommended institutions and maximum duration remain under constant review and will continue to reflect economic conditions and the credit outlook.

Interest rate forecast (December 2023)

Although UK inflation and wage growth remain elevated, the Authority’s treasury management adviser Arlingclose forecasts that Bank Rate has peaked at 5.25%.

The Bank of England’s Monetary Policy Committee will start reducing rates in 2024 to stimulate the UK economy but will be reluctant to do so until it is sure there will be no lingering second-round effects.

Arlingclose sees rate cuts from Q3 2024 to a low of around 3% by early-mid 2026.

Arlingclose expects long-term gilt yields to be broadly stable at current levels (amid continued volatility), following the decline in yields towards the end of 2023, which reflects the expected lower medium-term path for Bank Rate.

Yields will remain relatively higher than in the past, due to quantitative tightening and significant bond supply.

As ever, there will undoubtedly be short-term volatility due to economic and political uncertainty and events. 

Underlying assumptions:

• UK inflation and wage growth remain elevated but have eased over the past two months fuelling rate cuts expectations. Near-term rate cuts remain unlikely, although downside risks will increase as the UK economy likely slides into recession
• the MPC’s message remains unchanged as the Committee seeks to maintain tighter financial conditions. Monetary policy will remain tight as inflation is expected to moderate to target slowly, although some wage and inflation measures are below the Bank’s last forecasts
• despite some deterioration in activity data, the UK economy remains resilient in the face of tighter monetary policy. Recent data has been soft but mixed; the more timely PMI figures suggest that the services sector is recovering from a weak Q3. Tighter policy will however bear down on domestic and external activity as interest rates bite
• employment demand is easing. Anecdotal evidence suggests slowing recruitment and pay growth, and we expect unemployment to rise further. As unemployment rises and interest rates remain high, consumer sentiment will deteriorate. Household and business spending will therefore be weak
• inflation will fall over the next 12 months. The path to the target will not be smooth, with higher energy prices and base effects interrupting the downtrend at times. The MPC’s attention will remain on underlying inflation measures and wage data. We believe policy rates will remain at the peak for another 10 months, or until the MPC is comfortable the risk of further ‘second-round’ effects has diminished
• maintaining monetary policy in restrictive territory for so long, when the economy is already struggling, will require significant loosening in the future to boost activity
• global bond yields will remain volatile. Markets are currently running with expectations of near-term US rate cuts, fuelled somewhat unexpectedly by US policymakers themselves. Term premia and bond yields have experienced a marked decline. It would not be a surprise to see a reversal if data points do not support the narrative, but the current 10-year yield appears broadly reflective of a lower medium- term level for Bank Rate
• there is a heightened risk of fiscal policy and/or geo-political events causing substantial volatility in yields

Forecast:

• the MPC held Bank Rate at 5.25% in December. We believe this is the peak for Bank Rate
• the MPC will cut rates in the medium term to stimulate the UK economy but will be reluctant to do so until it is sure there will be no lingering second-round effects. We see rate cuts from Q3 2024 to a low of around 3% by early-mid 2026
• the immediate risks around Bank Rate have become more balanced, due to the weakening UK economy and dampening effects on inflation. This shifts to the downside in the short term as the economy weakens
• long-term gilt yields are now substantially lower. Arlingclose expects yields to be flat from here over the short-term reflecting medium term Bank Rate forecasts. Periodic volatility is likely

1. Where the council finances capital expenditure by debt, it must put aside resources to repay that debt in later years. The amount charged to the revenue budget for the repayment of debt is known as Minimum Revenue Provision (MRP), although there has been no statutory minimum since 2008. The Local Government Act 2003 requires the council to have regard to the then Ministry of Housing, Communities and Local Government’s (now Department for Levelling Up, Housing and Communities, DLUHC) Guidance on Minimum Revenue Provision (the MRP Guidance) most recently issued in 2018
2. The broad aim of the MRP Guidance is to ensure that capital expenditure is financed over a period that is either reasonably commensurate with that over which the capital expenditure provides benefits, or, in the case of borrowing supported by Government Revenue Support Grant, reasonably commensurate with the period implicit in the determination of that grant.
3. The MRP Guidance requires the council to approve an Annual MRP Statement each year and recommends a number of options for calculating a prudent amount of MRP. The following statement incorporates options recommended in the MRP Guidance:

• for capital expenditure incurred before 1st April 2008 MRP will be determined as 4% of the capital financing requirement in respect of that expenditure
• for capital expenditure incurred after 31st March 2008, MRP will be determined by charging the expenditure over the expected useful life of the relevant asset in equal instalments, starting in the year after the asset becomes operational. MRP on purchases of freehold land will be charged over 50 years. MRP on expenditure not related to fixed assets but which has been capitalised by regulation or direction will be charged over 20 years
• for assets acquired by leases or the Private Finance Initiative, MRP will be determined as being equal to the element of the rent or charge that goes to write down the balance sheet liability
• where former operating leases will be brought onto the balance sheet due to the adoption of the IFRS 16 Leases accounting standard, and the asset values have been adjusted for accruals, prepayments, premiums and/or incentives, then the annual MRP charges will be adjusted so that the total charge to revenue remains unaffected by the new standard
• for capital expenditure loans to third parties, the council will make nil MRP unless (a) the loan is an investment for commercial purposes and no repayment was received in year or (b) an expected credit loss was recognised or increased in-year but will instead apply the capital receipts arising from principal repayments to reduce the capital financing requirement instead. In years where there is no principal repayment on loans that are investments for commercial purposes, MRP will be charged in accordance with the MRP policy for the assets funded by the loan, including where appropriate, delaying MRP until the year after the assets become operational. Sufficient MRP will be charged to ensure that the outstanding capital financing requirement (CFR) on the loan is no higher than the principal amount outstanding less the expected credit loss. This option was proposed by the government in its recent MRP consultation and in the council’s view is consistent with the current regulations

4. Capital expenditure incurred during 2024/25 will not be subject to a MRP charge until 2025/26 or later.
    

This strategy was last reviewed in 2024. 

The next expected review date is 2025.