Originally Posted, 23 September 2024 – Monthly Cash Review – GBP State Street GBP Liquidity LVNAV Fund, August 2024
In a decision that was described as “finely balanced”, the Bank of England’s (BoE) Monetary Policy Committee (MPC) voted 5-4 at its meeting on 1 August to cut the base rate from 5.25% to 5.00%. MPC members Bailey, Breeden, and Lombardelli joined Dhingra and Ramsden in voting to lower rates for the first time since March 2020.
Economic Data
- Headline inflation rose from 2.0% in June to 2.2% in July, although the outcome came in lower than consensus expectations of 2.3%. An increase was expected given the energy base effects from the Ofgem price cap which kicked in on 1 July. Core inflation fell from 3.5% in June to 3.3% in July versus consensus expectations of 3.4%. Services inflation declined more than anticipated from 5.7% to a two-year low of 5.2%, below the BoE forecast of 5.6%.
- GDP for June was 0.0%, in line with expectations. Although services activity fell by 0.1%, industrial production rose by 0.8 and construction output increased 0.5%.
- GDP growth for Q2 2024 was reported at 0.6%, marginally lower than BoE expectations of 0.7%. Private consumption was softer than expected, although this was offset by stronger government spending.
- The composite purchasing managers’ index (PMI) rose from 52.8 in July to 53.4 in August, above consensus expectations of 52.9. Readings above 50 are indicative of economic growth. The uptick was driven by services (53.3, +0.8), while manufacturing output eased to 54.2 (-0.7).
- The unemployment rate declined from 4.4% to 4.2% versus consensus expectations for a small increase to 4.5%. Private sector pay growth, a focus for the BoE, declined from 5.6% to 5.2% — which was only marginally above the BoE forecast of 5.1%.
Outlook
The tone of the MPC meeting minutes, Monetary Policy Report (MPR), and press conference was cautious across the board. In its forward guidance, the MPC added that policy would remain restrictive for sufficiently long “until the risks to inflation returning to the 2% target had dissipated further”. Governor Andrew Bailey said that “we need to be careful not to cut rates too quickly or by too much”. Updated inflation forecasts saw a downward revision — the level is now expected to be 1.7% at the two-year horizon and 1.5% at the three-year horizon. The projection for GDP was revised higher in the near term, but there was no material change to the medium-term growth outlook. The MPC stated that it “will decide the appropriate degree of monetary policy restrictiveness at each meeting”.
The MPC would appear to want to see more evidence of declining inflationary pressures before implementing further rate cuts. The 10% rise in the Ofgem utility price cap on 1 October means that inflation for November is expected to increase. Another aspect is public sector pay deals that have outpaced inflation. While this is not expected to be inflationary on its own, there is a concern that this sets a benchmark for private sector firms, with wage and services inflation then remaining elevated. The main driver behind interest rate decisions is likely to be linked to services inflation, but the risk is more to the upside. From an economic data perspective, PMI data for August suggests GDP growth for Q3 2024 will slow from 0.6% in Q2 to a rate of around 0.3%.
Chancellor Rachel Reeves has revealed a £22bn black hole in the government budget for this year, following an audit by HM Treasury. A part of this relates to the increase in pay for public sector workers — this had previously been set at 2% but is now increased to between 5% and 6%. Reeves immediately cut back on some planned spending with an expectation of saving £5.5bn this year. The shortfall is expected to be funded by tax increases announced at the first budget of the new government, which is scheduled for 30 October.
Market implied rates (Figure 1) for September finished August at 4.90%, suggesting that rates are more likely to be maintained at the next meeting. However, the implied rate for November of 4.67% shows that the market has fully priced in a rate cut. The year-end implied rate also moved lower to 4.54%, suggesting the expectation of another interest rate cut.
Figure 1: Market Implied interest Rate Expectations
Source: Bloomberg Finance LP as of 30 August 2024 – 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. Past performance is not indicative of future results.
Fund
Yields for GBP investments moved lower following the interest rate cut on 1 Aug. Market expectations are that rates will be maintained at the September MPC meeting, with a cut to follow in November. With the fund’s weighted average maturity (WAM) already in the mid-40 day duration range, limited additional term trades were added to take advantage of higher yields offered at the time. Investments during August were mostly kept short, within a one-month duration. 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.
Figure 2: A Snapshot of UK Economic Data
Source: Office for national Statistics and Bloomberg Finance LP as of 30 August 2024 – Past performance is not indicative of future results.
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