Monthly Cash Review – EUR State Street EUR Liquidity LVNAV Fund, March 2024
Policy
At the European Central Bank (ECB) Governing Council (GC) meeting on 7 March, the deposit rate was maintained at 4.00% in line with expectations.
ECB Forecasts
The ECB revised lower both inflation and growth forecasts. Headline inflation for 2024 was revised down to 2.3% (-0.4ppts from its prior projection) on account of lower energy prices; for 2025, it is now expected to fall to its target of 2.0% (-0.1ppts); the 2026 forecast was left unchanged at 1.9%. Core inflation for 2024 was cut by 0.1ppts to 2.6%; for 2025, the bank reduced its estimate by 0.2ppts to 2.1%; and for 2026, the forecast was lowered by 0.1ppts to 2.0%. GDP growth forecasts were downgraded to 0.6% (-0.2ppts) for 2024, on weaker investment; were left unchanged at 1.5% for 2025; and revised up to 1.6% (+0.1ppts) in 2026.
Operational Framework Review
The ECB made a few changes in its operational framework review. Liquidity will continue to be provided through the weekly main refinancing operations (MRO) and the three-month long-term refinancing operations (LTROs). The deposit facility rate (DFR) remains the reference rate, with the spread for MRO reduced from DFR+50bps to DFR+15bps. The intention is to eventually introduce two new instruments to provide excess liquidity: a “structural portfolio of securities” and “structural longer-term refinancing operations”. The details of these tools are yet to be agreed but will probably be considered at the next review in 2026. The minimum reserve requirement (MRR) was maintained at 1% of eligible liabilities (predominantly deposits), despite some Governing Council members advocating to increase reserve requirements in order to drain liquidity. Excess liquidity in the Eurosystem currently stands at approx. €3.5 trillion, but with TLTRO maturities and ECB quantitative tightening, this is expected to reduce to approx. €2.5trn this year.
Data
- Headline inflation fell from 2.8% in January to 2.6% in February, slightly above consensus expectations of 2.5%. Energy inflation rose as expected, but this was more than offset by declines in food and core inflation. The core inflation rate fell from 3.3% in January to 3.1% in February, versus consensus expectations of 2.9%. Core goods inflation fell but services inflation registered only a marginal decline from 4.0% to 3.9%.
- The final euro area GDP growth figure for Q4 2023 remained unrevised at 0.0%.
- The euro area flash composite purchasing managers’ index (PMI) improved to 49.9 in March from 49.2 in February, slightly higher than expected (49.7) amid an improvement in the services PMI component to 51.1 from 50.2 (versus 50.5 expected). Readings below 50 are indicative of contracting activity.
- Euro area wage per employee, a key measure of inflation pressures, rose by 4.6% in Q4 2023, but this was lower than the 5.1% recorded for the prior quarter.
Outlook
While the latest headline and core inflation data showed declines in February, the outcomes were still above expectations. The composite PMI has shown improvement but it continued to point to stagnating activity in the opening quarter of 2024 — the important aspect to note is that the improvement was led by services. The labour market remains tight and data released after the ECB meeting showed that while wage growth slowed from 5.1% in Q3 2023 to 4.5% for Q4, this remains above the pre-pandemic level of 3.0%. This level is considered to be more broadly consistent with the ECB hitting its inflation target of 2% in the medium term, something the new ECB forecasts suggest will be achieved in 2025. However, the factors mentioned above (labour market tightness, wage growth, services inflation) could still hinder the disinflation process despite the new forecasts suggesting otherwise.
The market remains focussed on the timing for the first interest rate cut. The statement from the ECB noted that “although most measures of underlying inflation have eased further, domestic price pressures remain high, in part owing to strong growth in wages.” The messaging indicates the ECB wants to see more evidence that wage growth and underlying inflation are moderating before starting to lower rates. ECB President Christine Lagarde indicated that the GC is more confident on inflation retreating to the target level in a timely and sustainable manner, but it is not sufficiently confident yet. President Lagarde has strongly hinted towards a June rate cut by saying that "we need more data, we will know a little more in April, but a lot more in June." At the same time, the ECB has not explicitly committed to a path for rate cuts and has stated that data dependence remains key for future rate decisions. The market implied rate for April remained stable, finishing March at 3.88%. As the implied rate for June is 3.66%, this indicates the market expects a rate cut at the ECB’s June meeting. The year-end implied rate is now 3.02%.
Forecast are based upon estimates and reflect subjective judgments and assumptions. There can be no assurance that developments will transpire as forecasted and that the estimates are accurate.
Fund
The weighted average maturity (WAM) averaged 36 days in March and the weighted average life (WAL) averaged 57 days. Investments were made in high-quality credit issuers, out to three months, with some selective longer-dated investments. Investments in sovereign, agency, and government-guaranteed holdings were maintained to provide high credit quality and maintain liquidity buffers. Investments in bank floating money market securities, linked to the €STR overnight index, were increased, offering attractive spreads and diversification. Asset-backed commercial paper continued to be in good supply, offering flexible duration and attractive returns compared to vanilla paper. Liquidity and capital preservation remained the key drivers for the portfolio.