Monthly Cash Review - GBP State Street GBP Liquidity LVNAV Fund, October 2024
There was no meeting of the Bank of England’s (BoE) Monetary Policy Committee (MPC) in October. The next meeting is scheduled for 7 November.
Economic Data
- Headline inflation fell from 2.2% in August to 1.7% in September, which proved better than consensus expectations of 1.9% and the BoE projection of 2.2%. Core inflation fell from 3.6% in August to 3.2%, the lowest level since September 2021, compared to consensus expectations of 3.5%. This was partly due to a large drop in services inflation from 5.6% to 4.9% versus BoE expectations of 5.5%. Most of the fall in services inflation was attributable to a sharp decline in airfares inflation.
- GDP for August showed growth of 0.2%, which was in line with consensus expectations and followed two months of stagnation in June and July. Manufacturing output improved 1.1%, with services output inching up by 0.1%.
- The S&P Global composite purchasing managers’ index (PMI) declined from 52.6 in September to 51.7 in October, an outcome lower than consensus expectations of 52.6. Readings above 50 are indicative of economic growth. Both the manufacturing and the services output PMI fell. The employment PMI moved into contractionary territory for the first time since Q4 2023, falling to 49.1.
- The unemployment rate declined from 4.1% in July to 4.0% in August. Private sector pay growth, a focus for the BoE, eased from 5.0% (revised up from 4.9%) to 4.8%.
Markets
The fall in headline inflation below the 2.0% target for the first time since April 2021 was largely due to the expected fall in fuel prices. However, the bigger-than-expected decline resulted from a big fall in airfares inflation, which the BoE may not consider to be a sign that domestic price pressures are becoming less persistent. However, the 10% rise in Ofgem’s utility price cap on 1 October and some unfavourable base effects in clothing, communication, and recreation will likely send the inflation rate higher. According to the latest PMI press release, businesses put some activity on hold amid uncertainty ahead of the Budget and concerns over potential tax rises. This was likely a key driver behind the deterioration in activity metrics. The effect of budget concerns on activity could prove to be temporary. The rise in GDP growth in August, which came on the back of the economy failing to grow in three of the previous four months, suggests a slowdown in GDP growth in the second half of this year is more likely than a recession. The labour market continues to gradually cool, and wage growth has fallen.
The Budget
The market was paying close attention to the UK budget on 30 October. The result was a large £41.5bn increase in taxes by 2029/30. A substantial part of this was the £25.7bn rise in national insurance tax for employers. However, there is also a £47.0bn increase in current spending planned by 2029/30 along with a £24.6bn rise in public investment. The shortfall is to be funded by a £32.5bn rise in public borrowing.
Earlier in the month, BoE governor Andrew Bailey stated that the central bank could become “more proactive in cutting interest rates, provided inflation stayed subdued” likely contributed to the market pricing in two more interest rate cuts of 25 basis points before the end of2024. In the lead up to the budget, the markets became anxious around the potential for higher government borrowing to be announced, resulting in higher yields for UK gilts. Following the budget itself, the markets continued to express uncertainty around the fiscal outlook in the UK. The impact is expected to be seen in higher GDP growth in the near term, but inflation would also be expected to be higher than previously projected in this scenario meaning that the BoE may cut interest rates at a slower pace. The benchmark 10-year gilt yield rose 30bps, sterling weakened by around 1.5% against both the dollar and the euro, and UK equity markets have dropped by around 2%.
Market implied rates (Figure 1) for November finished October at 4.72%, suggesting an interest rate cut is now expected. The year-end implied rate rose to 4.64%, as expectations for a December rate cut diminished.
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
Continued uncertainty around the path of interest rates meant that investment duration was kept predominately short during October. Following the budget, markets moved to only price one further interest rate cut for 2024 and reduced the overall number of cuts in 2025. This provided an opportunity to add pockets of duration at the higher yields. Fund weighted average maturity (WAM) was maintained at a mid-30-day range throughout October. 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.