The UK economy made a lacklustre start to the year – unexpectedly failing to grow in January – even before the Middle East war sparked a global energy shock. The unemployment rate hit a near five-year high of 5.2% in the final quarter of 2025. However, a fall in inflation to 3% underpinned expectations of two rate cuts by the Bank of England (BoE) this year.
The US-Israeli attacks on Iran in late-February, blew those hopes out of the water.
The onset of the conflict, which led to Iran effectively blocking the Strait of Hormuz – a vital chokepoint for 20% of the world’s oil and gas – has sent global fuel prices soaring, which has prompted rapid readjustments for growth and inflation this year.
At its March meeting, the BoE voted unanimously to hold rates at 3.75%, and governor Andrew Bailey warned about the risk of rising inflation this year. In a significant turnaround, markets are now pricing in at least one 25bps rate rise by the BoE this year (at the time of writing, the US and Iran had agreed a two-week ceasefire).
The BoE was criticised for being slow to respond to the rise in inflation that began at the end of the Covid-19 pandemic and then accelerated because of the Russia-Ukraine war. Hopes that the rise would be ‘transitory’ turned out to be misguided as UK inflation soared above 10% in the second half of 2022.
The BoE’s hawkish tone this time around suggests its response will be more strident.
Figure 1: Implied overnight rate and number of forecast BoE hikes/cuts
Sterling flows
The UK gilt market has endured a torrid few weeks, amid concerns about how the worsening macroeconomic situation will affect the government’s fragile fiscal position. The 10-year gilt yield hit 5% in late March, pushing borrowing costs to their highest level since 2008.
The UK faces the biggest hit to growth from the Iran war of any G20 economy, according to the Organisation of Economic Co-operation and Development (OECD), which has slashed its economic growth forecast for the UK this year to 0.7% (from 1.2%).
The fraught market backdrop only bolsters the appeal of sterling-denominated money-market funds (MMFs), where the primary objective is capital preservation – potentially providing a safe haven for investors’ cash, no matter how turbulent market conditions become (as well as ‘same day’ access and a competitive rate of return).
Flows into sterling money market assets have continued to rise in recent months, despite the BoE cutting rates by 25bps in December. Total UK MMF assets had risen to £279bn at the end of March.
Figure 2: UK money market assets vs. BoE rates
Shortening duration
The asset class – a diversified pool of highly-rated, short-term debt securities – allows fund managers to adapt quickly to any abrupt turnaround in the macroeconomic outlook, and since the outbreak of the war many UK MMFs have shortened the duration of the whole portfolio.
While a reduction in weighted average maturity (WAM) might marginally impact the overall return, many managers’ primary concern at the present time will be maintaining the fund’s overall net asset value (NAV). One option to achieve this is to increase the overall ‘liquidity’ ratio of the portfolio and increase exposure to ultra-short-term instruments (with a duration of less than a week).
A top-tier MMF should be able to allow the manager to vary their position in the market at any given time as they respond to data and events
A top-tier MMF should be able to allow the manager to vary their position in the market at any given time as they respond to data and events; and many triple A-rated managers seek to be at the front of the curve to stay on top of a particular market dynamic. It plays to the strengths of a more conservative approved list of debt issuers – banks and sovereigns in Northern Europe, for example – which typically prove straightforward to trade in the market at any given time. An MMF portfolio that includes issuers from emerging markets and the Middle East might have the potential to be higher yielding, but it may also be trickier to adjust positioning.
At the end of the day, MMFs represent a potential safe haven – a place to store and protect capital – and amid the economic tumult from the Middle East crisis, which threatens to last for many months to come, they are likely to play an increasingly important role for global investors.
For more information on Liquidity.
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