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Introduction: Sterling volatility expected around the budget
Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.
The pound is in the spotlight as investors brace for tomorrow’s budget, fearful of a negative market reaction to Rachel Reeves’s plans.
The pound has weakened over the last few months, down from $1.36 in mid-September to $1.31 today, having hit a seven-month around $1.30 at the start of this month.
Traders are anxious as to whether the chancellor will manage to rebuild, or even increase, her headroom to hit the government’s fiscal targets in coming years.
Matthew Ryan, head of market strategy at financial services firm Ebury, predicts the pound will be volatile this week:
“It’s unclear if there will be enough room to raise taxes sufficiently to reach the required £25-30 billion shortfall, with the government reportedly ruling out hiking income tax rates and seemingly unable to cut fiscal expenditure.
“We instead see a sort of patchwork of assorted and targeted tax increases, but the devil will be in the details, and if Reeves is unable to convince markets that she has a credible long-term plan for fiscal sustainability, then the pound could struggle on Wednesday. At any rate, brace for volatility in sterling this week.”
According to the Financial Times this morning, traders have been “piling into bets” that the budget will push the pound lower against the dollar,
They report that trading volumes in put options, used to speculate on or hedge against a fall in the pound, have outstripped those of bullish call options by more than four to one over the past week, according to derivatives firm CME Group.
News yesterday that the UK’s growth forecasts will be downgraded has further dampened the mood:
The flurry of reports of potential budget measures over recent weeks – with an income tax rise first on, then off, the agenda – hasn’t reassured the markets.
Thomas Pugh, chief economist at audit, tax and consulting firm RSM UK, says this “chaos” is costly:
“The flip-flopping, U-turning and general chaos of the last couple of months means we are much less certain of what to expect in this week’s budget than usual.
“This raises three issues. First, chaos has a cost. The recent economic data make it clear that worries about the Budget is dragging on growth. Second, uncertainty raises the chances of an adverse reaction in gilt markets on the day if the budget disappoints. Third, the chances of additional rate cuts next year are falling quickly because it looks like the budget will be less deflationary and more backloaded.
A tax-heavy budget is likely to weigh on growth, increasing the possibility that the Bank of England cuts interest rates in December and again in 2026.
Ipek Ozkardeskaya, senior analyst at Swissquote, says tomorrow’s budget is “make-or-break’ for sterling, because…
..either the Bank of England steps in to prevent a gilt flare-up if investors dislike what they hear, or to cushion the economy if tax hikes bite hard.
The agenda
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11am GMT: CBI distributive trades report on UK retail
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1.30pm GMT: US retail sales report
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2pm GMT: Case-Shiller US house price index
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3pm GMT: Pending US home sales report
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3pm GMT: US consumer confidence report
