Both the Pound and gilts have traded in a relatively orderly fashion ahead of Chancellor Healey’s first Autumn Budget this afternoon.
Expectations are remarkably calm compared with the drama of recent years (e.g. the Truss mini-budget and Rachel Reeves's record tax rises). Markets are anticipating a cautious “do no harm” Budget, with only modest spending increases expected that would be funded by reallocating money rather than extra borrowing, along with some small targeted tax rises (likely to hit banks, online retailers, and gambling firms). With capital gains tax seemingly off the table, the immediate hit to growth should be limited, which has given some comfort to Pound buyers. The key focus will be on how much of a safety buffer Healey can rebuild under the government’s borrowing rules, after the recent surge in gilt yields eroded the previous one. Analysts think around £15bn would be enough to keep bond markets onside.
With a market-friendly Budget already priced in, the bar for a positive surprise for Sterling and gilts appears to be reasonably high. Therefore, any shortfall in the buffer, a lack of credibility in the spending plans, or larger-than-expected tax rises could quickly increase pressure on the Pound. Even then, if all goes smoothly, the Budget looks more likely to buy Healey time than to fix the UK’s underlying public finance problems, so any relief rally could prove short-lived.
In other news, the USD has been supported this week as AI sentiment has improved and investors brace for tonight’s Federal Reserve interest rate decision. No change in rates is expected, with odds of a hike at less than 10%, after several Fed officials played down the need to tighten following the recent high US inflation data. There will be no updated forecasts this time, so the focus will be on the tone of Chair Warsh’s press conference and whether he gives any hint of a December hike.
The Euro remains under pressure from the political uncertainty in France and is on course to be the worst-performing major currency this month. The gap between French and German 10-year bond yields recently widened to its highest level since the 2011 Eurozone debt crisis. That said, the move has so far been fairly orderly, suggesting markets see this as a France-specific problem rather than a wider Eurozone one. Tomorrow’s ECB meeting is also expected to deliver no change. However, President Lagarde may warn on inflation risks, which would keep the possibility of a December hike alive, so we could see some volatility during the accompanying press conference.
As a result, GBP/USD has dipped around 1% from last week’s high and trades around a 12-day low. The GBP/EUR has traded up towards fresh 17-month highs overnight. Meanwhile, the EUR/USD has touched fresh 17-month lows this morning.