Monthly Cash Review – GBP State Street GBP Liquidity LVNAV Fund, February 2025
At the Bank of England (BoE) Monetary Policy Committee (MPC) meeting on 6 February, the base rate was cut from 4.75% to 4.50% in line with market expectations. All nine members of the MPC voted for the rate cut, with two of the members voting to cut rates immediately by 0.50%.
Economic Data
- Headline inflation increased to 3.0% in January from 2.5% in December, above the 2.8% forecast by the BoE. The biggest driver of the increase was food, alcohol, and tobacco. Core inflation was in line with expectations of 3.7%, up from 3.2% in December. While services inflation for January rose to 5.0% from 4.4% in December, this was below the BoE forecast of 5.2%.
- GDP for Q4 2024 was reported at 0.1%, better than consensus expectations of -0.1%. GDP for December was 0.4%, beating the consensus estimate of 0.1%.
- The S&P Global composite purchasing managers’ index (PMI) for February fell marginally to 50.5 from 50.6 in January, slightly below consensus expectations of 50.6. Readings above 50 are indicative of economic growth. A small improvement in services activity to 51.1 (+0.3) was largely offset by a decline in manufacturing output to 47.4 (-1.8).
- The unemployment rate for December remained at 4.4%, which was in line with BoE forecasts. Private sector regular pay, a focus for the BoE, increased from 5.9% (revised down from 6.0%) in November to 6.2% in December, marginally below the BoE’s forecast of 6.3%.
Markets
The market focus shifted to the vote of two MPC members for a 0.50% cut in the base rate, although Governor Andrew Bailey was keen at post-meeting press conference to stress that the focus should not be on the vote split. The policy statement once again stated that rate cuts would be “gradual” and noted for the first time “careful”, and that rates need to remain “restrictive for sufficiently long” until inflation risks have diminished further. The MPC revised down its 2025 GDP growth forecast from 1.5% to 0.75% and revised up the CPI inflation forecast, expecting this to peak at 3.7% in Q3 2025, from its previous estimate of 2.8%. Looking forward, inflation in three years is expected to be 1.9%, up from a previous projection of 1.8%. The increase in inflation is attributed to rising energy costs, the changes in employers’ national insurance contributions, and water bills. The BoE concluded that the factors behind the short-term increase in inflation “would not lead to additional second-round effects on underlying domestic inflationary pressures” partly because the labour market conditions have eased. The focus is on the medium-term path of inflation and there has been little change in the view of a gradual disinflationary process.
From an economic data perspective, a lot of the weakness in GDP has been attributed to the rise in business taxes announced in October’s Budget as well as soft demand overseas. Business investment fell in Q4 2024 (the first decline in five quarters) and the recent falls in employment contributed to flat consumer spending. The main areas of growth were government consumption and investment. The February PMIs continue to paint a picture of subdued growth and deteriorating labour market conditions for the UK. The PMI composite employment gauge has reached its lowest level since June 2009, excluding the COVID period. While private sector regular pay grew, the pace of growth was below expectations with indications that wage settlements are slowing.
The position is unusual in that market expectations are based around interest rate cuts when inflation is above the 2% target and is expected to rise further. Key factors for the BoE will be whether businesses pass on more of the increases in national insurance contributions (NICs) and the minimum wage via their selling prices and whether there is additional easing in labour market conditions and wage growth pressures. Market implied rates (Figure 1) generally remained stable over the month. The implied rate for March finished the month at 4.44%. The implied rate for June was 4.16% and the year-end implied rate was 3.86%. The market is split between two-to-three more interest rate cuts over the remainder of the year.
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
Following the cut in the base rate in February and expectations of two/three more cuts through 2025, volatility remains high around the timing of future rate reductions. Investment yields across the 12-month curve remain positive to Sonia, providing some term premium against future rate cuts. The fund maintained a mid-duration weighted average maturity (WAM) in the 40 day range. The majority of investments were short-term with selected investments to three months. 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.