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Monthly Cash Review - GBP State Street GBP Liquidity LVNAV Fund, May 2024

At the Bank of England (BoE) Monetary Policy Committee (MPC) meeting on 9 May, the base rate was maintained at 5.25%, in line with expectations. The vote was 7-2, with Ramsden and Dhingra voting for a 0.25% cut in interest rates.

Economic Data

  • Headline inflation fell from 3.2% in March to 2.3% in April, which left it above BoE and consensus expectations of 2.1%. The decline was largely driven by the 12.0% fall in utility prices (due to the fall in the Ofgem price cap) and a further drop in food inflation. Core inflation eased from 4.2% to 3.9%, versus consensus expectations of a fall to 3.6%. Services inflation only fell from 6.0% to 5.9% against BoE and consensus expectations of 5.5%.
  • UK GDP for Q1 2024 grew by 0.6%, beating consensus expectations of 0.4%. GDP for March was 0.4%, which was also above expectations of 0.1%.
  • The unemployment rate ticked up from 4.2% in February to 4.3% in March, in line with the BoE’s forecast. Average earnings remained stable at 5.7%, with private sector wage growth slowing marginally from 6.0% to 5.9% — below the BoE forecast of 6.0%.
  • The composite purchasing managers’ index (PMI) fell to 52.8 in May from 54.1 in April, below consensus expectations of 54.0. Readings above 50 are indicative of economic growth. The decline was driven by services, which fell from 55.0 to 52.9. The manufacturing index improved to 51.3 from 49.1.

Outlook

The MPC maintained its previous guidance that policy needs to remain restrictive for “sufficiently long” and for “an extended period”. There was an additional comment in the latest statement, stating that the committee would “consider forthcoming data releases and how these inform the assessment that the risks from inflation persistence are receding.” Governor Andrew Bailey said that a cut at the next meeting in June was “neither ruled out nor a fait accompli”, but he also suggested that reductions in the bank rate could be “possibly more than currently priced into market rates”. Given the rise in market interest rate expectations, the BoE revised down its CPI inflation forecast in two years’ time from 2.3% to 1.9%. The BoE delivered its clearest signal yet that it is preparing the ground to cut rates soon.

From an economic data perspective, the smaller-than-expected fall in inflation and the continued ‘stickiness’ in services inflation suggests domestic inflation is fading slower than the BoE had assumed. This makes a June rate cut unlikely and casts some doubt over August too. The 0.6% rise in GDP in Q1 confirmed that the recession ended at the start of this year, but this prompted speculation that GDP growth could prevent inflation from falling towards the target rate and interest rates being kept higher for longer than previously anticipated. However, the GDP data was likely impacted by the earlier timing of Easter this year. The May PMIs will have provided the BoE with some comfort after the stronger-than-expected inflation data for April. The fall in the services output prices balance suggests that services inflation will continue to drop. Labour market data was broadly in line with the BoE's May MPR forecast. While private sector pay growth eased, it remains relatively strong.

There is still a wages and a CPI release to come before the BoE meeting on 20 June. Market implied rates (Figure 1) for June finished May at 5.19%. The timing of the first interest rate cut will ultimately be determined by inflation and labour market releases. The implied rate for August finished the month at 5.10%, suggesting that a rate cut is doubtful. The year-end implied rate also moved higher to 4.87%. Following the first interest cut, the debate will shift to how fast and far the BoE will cut rates.

Prime Minister Rishi Sunak surprised the markets by calling a general election for 4 July, and the polls point to a win for the opposition Labour Party. However, this is unlikely to alter the economic outlook. The constrained fiscal position will limit policy options with Shadow Chancellor Rachel Reeves previously pledging to keep the Conservative Party's primary fiscal (debt) rule.

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

Volatility around expectations for the timing of the first interest rate cut and the total number of cuts in 2024 remained high. Market expectations for the first cut is now fully priced for November (from August) and the total of cuts priced in for the year now stands below 50bps. Yields offered for GBP investments rose with issuers paying above 5.30% along the curve. Fund investments continued to add duration in high credit quality issuers with six-month maturities at the new market highs. A laddered investment approach to shorter duration credits (sub-3 months) was maintained as the yield curve continued to shift. The fund weighted average maturity (WAM) was extended from 40 days to 45 days. 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.

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