Cable traders will have a busy Wednesday, with two major events that could on their own shake up the markets. Analysts are anticipating a shift in the inflation trend. Then Chancellor Rachel Reeves will announce her much-anticipated Spring Statement. That will come along with new economic forecasts from the OBR.
Cable had some solid upward movement in early March, but it has since stalled out. That’s not entirely up to what’s going on in the UK. The dollar saw substantial weakness through February and early March, and has started to gain some footing. Meanwhile, the BOE last week decided to keep rates unchanged, but continued to signal that the trend was to the downside.
Getting a Handle on the Statement
There is both a policy and political component to the Spring Statement. First is the market reaction to what’s in it. The UK has been facing constricted finances as slow growth means revenue remains tight, while the government wishes to support GDP expansion with further spending. But with a high debt-to-GDP ratio, there isn’t much room for borrowing.
In the Autumn statement, the government raised taxes, which is seen weighing on economic growth and supporting inflation. Those higher consumer prices also impedes the BOE from helping the economy by lowering rates. Reeves promised she wouldn’t raise taxes again. But she can be outvoted by the Cabinet. If that were the case, the market expects that there is a very high chance of a change in the Chancellor. Reeves had had a calming effect on the markets given her banking background. The market could have an adverse reaction, depending on who replaces her if she’s shuffled out by Prime Minister Keir Starmer.
The Yields Problem
Typically, higher yields on government debt helps to strengthen a currency. But that’s usually for shorter-term debt, like rate-sensitive 2-year bonds. Higher rates further down the debt curve imply traders are pricing in a higher risk of default, which is often negative for the currency.
The reason why the currency goes up with yields is that the higher interest rate attracts investors who have to buy the currency in order to buy bonds. But in the UK’s case, deficit hawks have been selling long-term debt, forcing up yields. Which means investors are selling UK debt, which tends to weaken the pound.
What to Look Out For
Before the Spring Statement, however, is the release of February CPI figures, which are expected to show a modest decline. While this is turning in the right direction after January inflation accelerated, it might not convince many investors that a new trend is forming. There had already been one ‘fake out’ drop in December. It would likely take a substantial miss for the market to change its outlook for rate cuts this year.
UK February CPI on the headline is expected to come in at 2.9% compared to 3.0% prior. But a small beat would imply inflation is still rising, and could get the market worried that the BOE will not get around to cutting until at least the middle of next year. That could provide some upside to the pound. The core rate is expected to decline to 3.5% from 3.7% prior.
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