Monthly Cash Review - GBP State Street GBP Liquidity LVNAV Fund, August 2023
The Bank of England (BoE) Monetary Policy Committee (MPC) met on 3 August and hiked the bank rate by 0.25% to 5.25%, in line with expectations. There was a three-way split in the vote with two members, Mann and Haskel, voting for another 50bps rate hike and one member, Dhingra, voting to leave rates unchanged.
There was little change in policy guidance with the conditional phrase that “if there were to be more evidence of more persistent [inflationary] pressures, then further tightening in monetary policy would be required”. Also, the MPC stated that rates will be “sufficiently restrictive for sufficiently long to return inflation to the 2% target”. There was no guidance on the terminal rate.
Economic Data
- Headline inflation continues to fall, declining from 7.9% in June to 6.8% in July, in line with the BoE’s forecast. The fall was driven primarily by lower energy costs following the reduction in Ofgem’s utility price cap. However, core inflation remained stable at 6.9%, slightly above expectations for a small decline to 6.8%. Services inflation continues to increase from 7.2% to 7.4%, above the BoE forecast of 7.3%.
- GDP for June rose 0.5% (versus consensus expectations of 0.3%) and by 0.2% for Q2 2023, slightly above BoE expectations of 0.1%. The monthly increase was mostly due to the return to a normal number of working days in June after the additional bank holiday for the King’s Coronation in May.
- Unemployment has increased from 4.0% in May to 4.2% in June. However, one of the BoE’s preferred gauges of inflation persistence, private sector wage growth, rose from 8.1% to 8.3%. The three-month year-on-year rate of 8.2% was above the 7.6% the BoE had predicted in August.
- The composite purchasing managers’ index (PMI) was weaker than expected, falling from 50.8 in July to 47.9 (consensus 50.3) in August. Readings below the 50 level are indicative of economic contraction. The fall was led by the services PMI, which fell from 51.5 to 48.7. The composite employment balance also declined, from 51.5 to 50.4. The press release suggested that demand was weakening due to “higher interest rates and stretched disposable household incomes”.
Outlook
The guidance from the BoE MPC at the start of the month continued to signal upside risks to inflation. The BoE added resilience in the economy to its other indicators of persistent inflationary pressures, the labour market, wage growth and services CPI inflation. The market focus continues to be firmly on economic data. The month has seen headline inflation continuing to fall while core inflation remains stubbornly high. Perhaps more importantly as an indicator, services inflation continued to increase. The higher unemployment rate provided some comfort, but wage growth continues to strengthen. The monthly GDP data showed resilience and the quarterly data confirmed that a recession had been avoided. However, PMI data suggested that economic momentum is weakening, with the potential for a weaker economy to reduce inflation. Prior to the next BoE MPC meeting in September, there will be another labour market and inflation release. The path of interest rates is likely to be dependent on data surprises relative to forecast.
Market implied rates (Figure 1) started the month with an implied peak close to 5.75%. This initially moved higher to 6.00% on the back of strengthening wage growth. Implied rates moved lower following the weaker-than-expected PMI data. Market expectations at the end of the month were more inclined towards a rate hike at the September policy meeting with an implied rate of 5.41%. The implied peak is now between 5.50%-5.75%.
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 surprise 50bps rate hike at the June MPC meeting, markets remained volatile around the path to the rate Money market volatility remained high throughout August following the BoE lifting rates by another 0.25% on 3 August. The hawkish rhetoric from the BoE continued to see markets price in more hikes. As economic data was released, market expectations changed. With this continued uncertainty, fund maturities continue to be mostly short term in duration, within 30 days, maintaining the weighted average maturity within a high 20-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.