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Monthly Cash Review - GBP State Street GBP Liquidity LVNAV Fund



The Bank of England Monetary Policy Committee (MPC) raised the Bank Rate as expected and acknowledged in its guidance that the impact of high inflation could prompt it to join the growing global trend of larger hikes. This provides the flexibility to move as appropriate depending on economic data. And concerns do remain around economic prospects given the on-going Russia/Ukraine War, further energy price increases, high inflation and its impact on household real income, and the strength of the labour market that puts upward pressure on wages.

Following the end of the month in June, mass resignations by members of the UK government made the position of the Prime Minister, Boris Johnson, untenable. He subsequently agreed to resign, setting in motion a leadership election to find his replacement.

Policy

In line with expectations, the Monetary Policy Committee (MPC) raised the Bank Rate for a fifth straight meeting, lifting it by 25 basis points (bps) to 1.25%. The vote was 6-3 with Michael Saunders, Catherine Mann and Jonathan Haskel voting in favour of a 50bps increase. Guidance now links the "scale, pace and timing" of further rate increases to underlying inflation. The MPC also stated that it would “act forcefully” if inflation pressures are more persistent. Given the current uncertainty, this offers the flexibility for larger increases, if required, to control inflation. The inflation forecast was raised again to slightly above 11%, reflecting the planned increase in the energy price cap in October 2021.

Data

GDP for April fell 0.3% month-on-month (m/m), the second consecutive decline and worse than consensus forecasts for a rise of 0.1%. Services fell by 0.3% in the month, but this was largely due to a 5.6% decline in human health and social work following the end of NHS Test and Trace activity – without this, the economy would have grown 0.1%. Consumer-facing services rose by 2.3%, led by retail sales and other personal services. Production fell by 0.6%, driven by a fall in manufacturing of 1.0% as businesses continued to report the impact of price increases and supply chain shortages.

There was a small increase in CPI inflation from 9.0% in April to 9.1% in May (versus consensus expectations of 9.1%). Food price inflation increased from 6.7% to a 13-year high of 8.5%, but this was partly offset by falls in clothing inflation (from 8.3% to 7.0%), and recreation/culture inflation (from 5.9% to 5.0%). Core CPI inflation eased back from 6.2% to 5.9%.

The flash Composite purchasing managers’ index (PMI) was unchanged at 53.1, topping consensus market expectations – readings in excess of 50 are indicative of growth. Business activity was flat while manufacturing output fell by 0.4 points. Services continued with some post-COVID recovery momentum. Forward-looking indicators showed new orders falling by 3.2 points in services and by 1.5 points in manufacturing.

The unemployment rate edged up from 3.7% to 3.8% for the three months to April. The single-month data showed that employment fell by 254,000 in April and the unemployment rate rose from 3.5% in March to 4.2%.

On the consumer front, retail sales volumes in May fell 0.5% m/m (consensus -0.7%), marking the third decline in four months. This suggests that inflation is impacting real incomes and consumers capacity to maintain spending levels. The GfK measure of UK consumer confidence fell from the all-time low of -40 it recorded in May to a new low of -41 in June.

The Office for Budget Responsibility (OBR) revised up borrowing for April from £18.6bn to £21.9bn, while borrowing in May of £14.0bn was worse than the OBR forecast of £10.3bn, due to lower tax receipts and higher interest costs.

Outlook

The MPC has added a degree of flexibility to its rate guidance to allow for larger rate hikes should higher inflation be sustained. There remains a fine balance in avoiding a recession. Inflation is expected to rise above 11% in Q4. The minutes from the latest meeting notes there were “mixed signs” on the extent to which the living standards squeeze was weighing on consumer spending. Confidence has dropped but “indicators had held up.” Inflation data released during the month did not appear to meet the criteria of more persistent inflationary pressures.

Markets

After the MPC meeting, market rate expectations became more hawkish on the assumption that more action would be required and that the size of hikes could be altered if necessary. Markets began pricing in hikes of 50bps at the next three meetings with a further 25bps increase for December – this would take the Bank Rate to 3% by year-end before then peaking at 3.5% in 2023. Following the latest inflation data release, this expectation was revised, with the chances of a 50bps hike at the next meeting on 4th August seen as 50/50, with the market pricing in a year-end rate of 2.75% and a peak of 3%. Money markets remained liquid throughout the month, with yields focused on central bank policy.

Fund

The fund assets under management (AUM) remained constant over the month at just below GBP 5 billion. The weighted average maturity (WAM) was increased to a mid-40-day range with more investments extended out the curve, taking advantage of an aggressively positive yield curve that priced a series of 50 basis point rate hikes. Shorter-dated trades were placed to the next MPC meeting in August, one-month and one-week in duration. Overnight and seven-day liquidity requirements were exceeded throughout, including the always difficult quarter-end period, 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*.


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