Monthly Cash Review - GBP State Street GBP Liquidity LVNAV Fund, February 2023
In line with expectations, the Bank of England (BoE) Monetary Policy Committee (MPC) voted 7-2 to raise the policy rate at its 2 February meeting by 50bps to 4.00%; Silvana Tenreyro and Swati Dhingra favoured leaving rates unchanged. Updated forecasts were released in the Monetary Policy Report, and these were less downbeat than previously recorded. This improvement was based on the fall in energy prices, a fall in the policy rate, and an assumption that households will be less cautious given the continuing tightness in the labour market. The scale of the projected recession has been reduced to a 1.0% peak-to-trough fall in real GDP over five quarters. Inflation is expected to fall to 4.0% by the end of this year, to 1.0% by the end of 2024 and just above 0.0% by the end of 2025.
The focus for the remainder of the month was on economic data. GDP for December fell 0.5%, but for the fourth quarter overall GDP was unchanged, avoiding a recession as defined by two consecutive quarters of contraction. Inflation fell to 10.1% in January, in line with the BoE’s forecast. Fuel price inflation continues to decline but food price inflation remains strong. Core CPI inflation fell more sharply than expected to 5.8% from 6.3%. The biggest surprise was the sharp rebound in the flash UK composite purchasing managers’ index (PMI) for February into expansionary territory at 53.0, above consensus expectations of 49.1 — readings above 50 are indicative of growth. This was driven by the services PMI, suggesting that price pressures remain in the services sector. The unemployment rate remained unchanged, but wage growth was strong — the three-month year-over-year (yoy) rate of average earnings growth (excluding bonuses) increased from 6.5% in November to 6.7% in December. The data shows that the economy has remained resilient amid high inflation, high interest rates, and a tight labour market.
Outlook
The guidance from the MPC was amended from previous meetings, with the reference to acting ‘forcefully’ being removed and “further increases in Bank Rate may be required” changed to a more conditional “if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required”. The MPC also stressed that the "risks to the inflation outlook are skewed significantly to the upside", implying potential for further modest policy tightening. At the same time, the BoE acknowledged that it would look at "the impact of the significant increase in Bank Rate so far” suggesting that it believes it is approaching the end of the tightening cycle. At this time, market expectations were for a peak rate of 4.25%, with the potential for a cut to below 4.00% by the end of the year. This changed as February progressed and data showed that the economy remained more resilient than anticipated, with signs of persistent inflationary pressures. While inflation fell, the labour market remains tight, indicators of future pay growth remain strong, and the growth in the composite PMI was driven by the services sector. The tone on markets turned more hawkish with rates now expected to peak at 4.75%, with the potential to remain higher for longer due to the resilience in economic activity.
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 path for policy rates still uncertain following the early-February MPC meeting, most investments for the fund were kept short in duration with the focus on the next MPC meeting on 23 March. Investments around a three-month maturity were added, together with a small allocation of six-months trades where market yields were advantageous. The WAM (weighted average maturity) remained steady throughout the month around a mid-30 day range. 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.