The pound has rallied recently towards four-week highs amid a relatively light economic calendar. The move has made sterling the top performer among major currencies, thanks in part to an improving economic outlook. Those gains could face a test this week. The main UK risk event is the Autumn Budget, which the government will publish on Wednesday.
Earlier in the month, UK joblessness fell to its lowest level this year, reaching 4.7% versus the expected 4.9%. Alongside wages growing faster than inflation, this has increased the odds of a rate hike. Futures are pricing in an over-90% chance that the BOE will hike rates next week. Meanwhile, markets expect other major central banks to hold rates. This outlook depends on the British economy remaining resilient. However, concerns remain that the Autumn Budget could include measures that might impede growth.
From Stability Premium to Budget Anxiety
The pound benefited heading into autumn after a relatively smooth leadership transition to Prime Minister Andy Burnham. Chancellor John Healey has largely maintained his predecessor’s pro-market policies. Investors remain wary of the volatile situation in France and the US. As a result, they have increasingly opted to invest in the UK, lowering gilt yields while supporting equities. The buying pressure has helped prop up the pound.
Investors see the Autumn Budget as the single largest domestic market catalyst this week. They fear it might signal a departure from the status quo. The Chancellor faces very tight financial conditions. Rumours also suggest that the government might increase taxes, which could slow down the economy.
Markets Prepare for Some Uncertainty
Leaks so far suggest that Healey will not raise capital gains taxes, one of investors’ primary concerns. Such a move would likely drag down the stock market and discourage foreign investment. Nevertheless, the market is likely acting with hesitation ahead of the Budget. This suggests the potential for a relief rally even if there aren’t any major surprises.
Analysts estimate that the Chancellor has between £10 and £15 billion in fiscal “headroom”. The government could direct that money towards new spending initiatives without raising taxes. If proposed spending exceeds that amount, markets could worry about additional government borrowing and rising inflation. This could push long-term yields higher and weigh on the pound.
What the Market Is Looking For
Generally, the fewer major changes the government announces, the more positively markets are likely to react. Therefore, market volatility will likely centre on uncertainty. The more certainty the Budget provides, the more likely markets will react positively. Investors will also welcome signs of future growth that could attract investment and bolster the pound.
However, the Budget could also unsettle markets in several ways, leaving the overall risk to the downside. Analysts anticipate a 3% surcharge on banks, which could hurt one of the UK’s premier growth industries.
Markets also expect Healey to announce over £20 billion for the National Wealth Fund. However, they don’t expect the government to start borrowing for it until the next fiscal year. Delaying the funding would reduce immediate pressure on the bond market, helping to reassure investors.
