Monthly Cash Review - GBP
GBP Liquidity LVNAV Fund
The Bank of England (BoE) Monetary Policy Committee (MPC) raised interest rates by 50bps in response to increasing inflationary pressures. Following this, CPI inflation for July was reported at 10.1%, topping BoE forecasts. An increase of 80% to the utility price cap, effective 1st October, adds to price pressures as wholesale gas prices continue to rise; a further utility price cap increase is expected for January. The tight labour market and growing domestic inflationary pressures appear to meet the criteria for the MPC to “act forcefully” in response to “more persistent inflationary pressures”. The market has priced in another 50bps increase at the 15th September MPC meeting, a year-end rate of 3.5%, and a peak of between 4.25%-4.50% within the next six-to-nine months as it expects inflation to be higher than current BoE estimates.
On the political front, Liz Truss is set to become the leader of the Conservative Party and the next prime minister (due to be announced on 5th September). This will likely result in additional fiscal support in terms of tax cuts of about £30 billion and more financial support to help with rising energy bills. There is also a suggestion that the mandate given by the Treasury to the BoE may be reviewed (currently defined as keeping inflation at 2% on the CPI measure).
The Bank of England Monetary Policy Committee voted 8-1 in favour of increasing the policy rate by 50bps from 1.25% to 1.75%.
The UK economy weakened in June, with GDP declining 0.6% month-on-month (m/m), a better outcome than consensus expectations of -0.9%, primarily due to the extra Jubilee bank holiday. Services output fell 0.5% m/m, construction output by 1.4% and manufacturing output by 1.6%. The GDP data confirms that the economy contracted by 0.1% on a quarter-on-quarter basis (q/q) in the second quarter.
CPI inflation rose from 9.4% in June to a new 40-year high of 10.1% in July that was above the BoE projection of 9.9%. Fuel prices rose 2.0% m/m, although the recent fall in oil price suggests that it will have a downward impact on inflation in coming months. Food inflation increased from 9.8% to 12.6%. Indications are that the global drivers of inflation are being replaced by domestic ones, with services inflation up to a 30-year high of 5.7%.
The flash S&P Global/CIPS composite purchasing managers’ index (PMI) fell from 52.1 in July to 50.9 in August. The services PMI declined marginally from 52.6 to 52.5 but the manufacturing PMI recorded the biggest monthly decline since the first COVID-19 lockdown, falling from 52.1 to 46.0. Readings below 50 are indicative of contracting activity.
Retail sales increased 0.3% m/m in July driven by a 4.8% increase in non-store (online) sales. Clothing sales fell by 1.2% in the month, household good sales declined by 0.4% and fuel sales fell 0.9% due to high petrol prices.
The ILO unemployment rate held steady at 3.8%. The labour market remains tight and average earnings growth fell from 6.4% in May to 5.1% in June, due to slowing growth in bonus payments.
Public sector net borrowing (excluding banking groups) for July of £4.9bn was higher than the forecast by the Office for Budget Responsibility of £0.2bn due to higher expenditure following the first instalment of the Chancellor’s cost-of-living package announced in May.
The MPC will now decide the “appropriate level of Bank Rate at each meeting”, depending on the data. The MPC has stated that it will “act forcefully” in response to “indications of more persistent inflationary pressure” and raise rates by 50bps again should the inflation data remain strong. The current forecast is for a recession, with GDP expected to decline for five quarters from Q4 this year, by 2.1% in total. Inflation has been revised upwards to peak at 13.3% in Q4 and the MPC expects that “it will remain very elevated throughout much of 2023”.
Market expectations shifted during the month in response to sustained inflationary pressures. With wholesale gas prices continuing to increase, the utility price cap was further raised by 80% from 1 October with another rise expected in January 2023. Inflation risks remain elevated as a result, with market expectations for the annual inflation rate ranging between 14.5% and 18.5% depending on future utility cap increases. The market also began to price in more interest rate increases. A 50bps rate hike has been fully priced in for the next MPC’s meeting on 15th September. The year-end implied rate is now expected to be 3.25%-3.50%, rising to 4.25% in 2023. Money markets remained liquid throughout the month, with yields focused on central bank policy.
The fund assets under management (AUM) experienced a small decline to end the month at £5 billion from £5.2 billion at end of July. The weighted average maturity (WAM) fell slightly but remained in a low 40-day range. Considering heightened uncertainty around rate hike sentiment the vast majority of investments were kept short, in and around the September MPC meeting. Overnight and seven-day liquidity requirements were exceeded throughout August and were well in excess of minimum requirements. 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.
* Source: State Street Global Advisors as of 21 August, 2022
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