Monthly Cash Review - GBP State Street GBP Liquidity LVNAV Fund, December 2023
The Bank of England (BoE) Monetary Policy Committee (MPC) voted to leave the base rate unchanged at 5.25% on 14 December in line with market expectations. The vote was 6-3, with the three dissenters voting for a 0.25% rate increase. The MPC maintained a hawkish tone, retaining previous forward guidance that rates “would need to be sufficiently restrictive for sufficiently long” and that “further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures”. The intention was to push back against market expectations of early interest rate cuts.
Economic Data
- Inflation data for November proved to be lower than expected. Headline inflation fell to 3.9% from 4.6% in October, versus consensus expectations of 4.4% and BoE projections of 4.6%. Core inflation declined to 5.1% from 5.7% for October against consensus expectations of 5.6%. Services inflation fell from 6.6% to 6.3% against consensus expectations of 6.6% and BoE projections of 6.9%. Core goods inflation, fuel inflation, and food price inflation continued to ease.
- GDP for October contracted by -0.3% versus consensus expectations for a decline of -0.1%. The fall was broad-based across services, industrial production, and construction. GDP for Q3 2023 was confirmed to have fallen by -0.1%, with Q2 2023 growth revised down to 0.0% from an initial estimate of 0.2%. This showed that higher interest rates were impacting consumer spending.
- The composite purchasing managers’ index (PMI) surprised to the upside, rising from 50.7 in November to 51.7 in December, better than consensus expectations of 51.0. Readings above 50 are indicative of economic growth. The improvement was driven by the increase in the services activity reading from 50.9 in November to 52.7. The output for the manufacturing sector dropped from 49.2 to 45.9. The composite employment reading edged down from 49.8 to 49.2.
- The unemployment rate remained unchanged for October at 4.2%. Private sector regular pay growth slowed to 6.4% in October from 7.5% in September.
- Retail sales volumes for November rose 1.3%, better than consensus expectations of -0.1%. The rise was broad-based across all sectors but the largest gain was recorded in household goods stores sales.
Outlook
The inflation data surprised to the downside, with headline annual Inflation and services inflation coming in lower than BoE's November forecasts by 0.70% and 0.60%, respectively. The potential for a lower future energy price cap also adds to the disinflationary outlook. Inflation is falling faster than anticipated. Labour market data has seen softer wage data and signs that momentum is slowing. Data on activity was more mixed. GDP contracted in October but December’s PMI data suggests that activity in the fourth quarter will show modest growth, attributed to strengthening in the services sector. This lessens the risk of a near-term recession. The BoE still has concerns about upside risks to with the persistence of wage inflation and services inflation remaining much too high. The hawkish tone of the bank’s statement was to counter market expectations for early interest rate cuts. In order for the BoE to cut interest rates, it is likely to want to see data confirming wage and price disinflation with both headline and core inflation converging to the target level. The next BoE Monetary Policy Report is due in February 2024, and inflation projections are expected to be lowered, which in turn will drive market expectations for rate cuts.
Market implied rates (Figure 1) moved in line with economic data. The implied rate for the both February and March 2024 have remained relatively stable, finishing the month at 5.18% and 5.10%, respectively. Given market assumptions around declining inflation, the implied rate for May 2024 shows expectations for rates to be cut, finishing the month at 4.89%. Further rate cuts are expected with the implied rate for September 2024 ending December at 4.04%.
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
With the BoE maintaining policy rates at 5.25% in December, inflation falling more than expectations, and a sprinkle of softer wage growth data, the sterling yield curve continued to trend lower during December. Against this backdrop, to lock in higher yields, the fund continued to add investments in excess of three month duration, whilst maintaining core shorter maturities, with fund duration already having been moved into mid-40 day range over the fourth quarter, where it was maintained. Excess liquidity margins remained high and balanced as we moved closer to pivotal year-end positioning. Fund liquidity requirements, both overnight and weekly were well in excess of minimum requirements at all times. Fund liquidity was covered with a combination of government and supranational holdings, gilt repo, and bank deposits. The fund credit rating exceeded requirements at all times.