Monthly Cash Review - GBP State Street GBP Liquidity LVNAV Fund, October 2023
There was no Bank of England (BoE) Monetary Policy Committee (MPC) meeting in October, with the next meeting scheduled for 2 November. Market focus through the month was on economic data.
Economic Data
- Headline inflation remained unchanged from August at 6.7% which was better than BoE expectations of 6.9%. Core inflation fell from 6.2% in August to 6.1% in September versus consensus expectations of 6.0%. This was due to a further fall in core goods inflation, but a worrying development was that services inflation increased from 6.8% to 6.9%.
- GDP rose by 0.2% in August, in line with expectations, led by services. There was a downward revision to July GDP from a -0.5% contraction to -0.6%.
- The Office for National Statistics (ONS) published an alternative Labour Force Survey (LFS) for August due to a low response rate. This was derived from HMRC PAYE figures and the claimant count for the three months to July and the three months to August. This showed the decline in employment improved from -133,000 in July to -82,000 in August, resulting in an unemployment rate of 4.2%. Private sector wage growth eased from 8.1% to 8.0%.
- The composite purchasing managers’ index (PMI) for October remained relatively stable at 48.6 from 48.5 in September, broadly in line with expectations. Readings below 50 are indicative of economic contraction. The UK composite PMI has now been below the neutral 50 level for three consecutive months.
Outlook
October saw the elevation of geopolitical risk with the start of the war between Hamas and Israel and the potential for this to escalate to the wider region. Diplomatic efforts are on-going to try to de-escalate tensions in the Middle East. This outbreak of hostilities has cast a shadow from an economic point of view, especially on the outlook for inflation due to the upside risk to oil and wholesale gas prices.
Economic data has been broadly in line with expectations, but suggests that the economy is weakening. GDP data shows that the UK economy is potentially facing a mild contraction in Q3 2023. Also, the longer the composite PMI remains at current levels, the higher the risk of recession. These weaker data points are signs that higher interest rates are impacting both households and corporates through lower bank lending and a slowing housing market. The loosening in the labour market has so far been modest and private sector wage growth remains an area of concern for the BoE, as this continues to fall slowly. BoE Chief Economist Huw Pill believes that the UK is subject to persistent inflation pressure, but he emphasised that rates needed to remain restrictive. While there are upside risks to inflation from higher oil and gas prices, triggered by the conflict between Hamas and Israel, a large fall in headline inflation is expected for October. This is due to the pre-announced fall in the Ofgem utility price cap, with headline inflation expected to decline to approximately 5.0%. This is likely to lessen the pressure on the BoE to raise Bank Rate in November.
Market implied rates (Figure 1) have continued to fall. The implied rate for the November meeting finished the month at 5.18%. The year-end implied rate finished October at 5.25%. Interest rates are expected to remain stable. having been as high as 5.69% earlier in the month. Many in the market now believe that interest rates are at their peak. The implied rate for June 2024 finished the month at 5.12%.
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 BoE decision to maintain the base rate at 5.25% in September, the volatility in money markets eased, based on the expectation that the BoE had reached the top of the hiking cycle. Yields within a six-month maturity fell by around five basis points, with yields out to 12-months some 10 basis points lower. The fund continued to add pockets of duration to lock in some higher yields, taking the WAM to within 40 day period. The fund still maintained a high level of short duration holdings ahead of the November MPC meeting. 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.