Despite all the doomsaying prior to Budget announcement, the pound has performed quite well since Wednesday and gilt yields have edged lower.
Markets appear to be reassured by the larger-than-expected fiscal headroom (more than double that afforded by the chancellor last year) and the lack of any real surprises in the tax announcements. A larger headroom should reduce the chances that Labour will need to raise taxes again this time next year, which is providing some comfort to markets.
However, notable risks remain. Most of the tax hikes that were unveiled are backloaded (e.g. freeze to income tax thresholds), which means that it will be while before these revenues are actually realised. Furthermore, it’s very difficult to see where the growth comes from in the budget, which is concerning given the OBR’s recent downgrades to both their growth and productivity medium-term forecasts. The additional £26bn annual tax burden (on top of last year’s £40bn) will add further pressure onto struggling households and businesses. Market expectations for a December BoE interest rate cut have now risen to around a 92% chance.
In other news, growing expectations of another Federal Reserve rate cut in December (now priced in around 80%) continues to weigh on the USD. US data has been on the softer side of late and recent reports suggest that Kevin Hassett, a close Trump ally, has emerged as the leading contender to become the next Federal Reserve Chair. He’s considered the most dovish candidate in the field and therefore more likely to push for lower US interest rates. The market reaction off the back of this news story has been relatively contained so far, however, we expect that speculation around the Fed leadership will intensify as the current Chair’s term approaches its end in May.
As a result, the GBP/USD has risen around 1 cent since Wednesday and trades close to a 4-week high. It will be interesting to see how this currency cross moves as the BoE and Fed both now look certain to cut rates at their meetings next month. The GBP/EUR is around 0.75% higher and is trading at a similar 4-week high.
