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.
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
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.