GBP made gains against the USD, surpassing the $1.27 mark and reclaiming a position above €1.17 against the EUR yesterday. This upward movement seemed to be a result of the selling spree of the USD following the ISM report. Today, attention is focused on the UK Budget, and if moderate tax cuts contribute to a steady increase in UK gilt yields, the pound could experience an upward jolt.
UK Chancellor Jeremy Hunt faces a delicate balancing act in determining the scope of fiscal measures, given the challenges of a persistent inflation outlook and lack-luster growth forecasts in the UK economy. The government's net borrowing position remains a key consideration, requiring a careful balance between economic recovery efforts and fiscal responsibility. The challenge lies in supporting public services, stimulating economic growth, managing the national debt, and responding to external economic pressures.
With the UK economy having entered a recession in the final quarter of 2023 and the market adjusting expectations for Bank of England (BoE) rate cuts, Chancellor Hunt's fiscal flexibility is limited. The possibility of significant tax cuts ahead of a potential 2024 election may be less likely. The market's repricing of BoE rate cuts has led to higher borrowing rates in recent weeks, constraining Hunt's fiscal options. The reduced scope for tax cuts could increase expectations of early BoE rate cuts, putting pressure on the sterling.
On the other hand, an excessively large and unfunded fiscal stimulus could heighten concerns about persistent inflation, potentially causing turmoil in gilt yields and weighing on the pound. A moderately-sized tax relief package that avoids triggering gilt market disruptions might offer some support to the sterling, possibly pushing GBP/USD closer to its 2024 peaks around $1.28. While the UK gilt market experienced a significant downturn 18 months ago, a similar level of turbulence is not anticipated today. Nevertheless, surprises are always possible in the financial markets, and traders should remain vigilant.
