Despite the looming UK Spring Budget this Wednesday, market sentiment remains calm in anticipation of the event. This tranquillity contrasts sharply with the conditions during the Liz Truss fiasco in October 2022, where implied volatility soared to levels comparable to the Brexit vote and Covid shock. This led to a historical disconnect with UK gilt yields surging and the pound plummeting, reaching a record low below $1.05 in GBP/USD. Since then, GBP has experienced fluctuations, recovering above $1.30 in July 2023, dropping to $1.20 in October 2023, and stabilizing between $1.25 and $1.28 over the past three months. This period of relative calm is unusual but lends support to GBP due to its high-yield appeal in carry trades. The question now is whether the upcoming UK fiscal event will disrupt this stability. While fiscal events typically don't heavily impact FX markets, the prospect of a UK election may prompt the Chancellor to unveil a significant package of tax cuts, despite constraints from increasingly tight fiscal forecasts.
UK Chancellor Jeremy Hunt has cautioned that there is a "long path" ahead to reduce Britain's tax burden, currently at its highest in 70 years. Yet, potential fresh tax cuts could exert upward pressure on yields, which are already near 15-year highs. Substantial cuts to income tax would provide additional motivation for the Bank of England to maintain interest rates at their current levels for an extended period.
The EUR staged a late recovery at the beginning of the new month, gaining momentum as a hotter-than-expected inflation print for the Eurozone boosted the common currency against the USD in the final stretch of the week. The yield on the 10-year German government bund retreated toward the 2.4% mark, down from the three-month high of 2.50% on February 29, as investors considered the subsequent monetary policy implications ahead of the ECB rate decision this week.
On a weekly basis, EUR/USD remained largely unchanged, registering only a marginal 0.1% week-on-week gain to close above the $1.0830 mark. Mid-last week, the pair entered a slight bearish streak, suggesting that further downside for EUR/USD cannot be ruled out. A breach below $1.0800 could attract EUR sellers, potentially paving the way for an extended slide toward $1.0760. Conversely, signs of a slowdown in the US economy or labour market could see EUR/USD testing $1.0870 before confronting the psychological barrier of $1.0900.
