Pound and gilts traders will focus on a potential downgrade to the UK growth outlook this week, a challenge for a government under pressure to reduce austerity and deliver Brexit progress.
Sentiment in the sterling options market turned the most bearish in a month last week, ahead of a budget on November 22 that could see a significant economic downgrade. This makes for a “political high-wire act” for the government and UK. Chancellor Philip Hammond himself, said Jeremy Stretch, head of Group-of-10 foreign-exchange strategy at Canadian Imperial Bank of Commerce.
“Hammond’s got very little fiscal room to manoeuvre and it’s going to be interesting to see how he deals with that,” Stretch said. “If there’s some easing of the fiscal side he will be criticised by the deficit hawks, alternatively if he is not sufficiently upbeat then his own future will once again be in clear and present danger. So there’s a little bit of political risk”, he said, adding he would sell the pound on any rallies.
Sterling touched a two-week high versus the dollar on Friday but then slid to wipe out the gains. While the British currency saw some support last week against a faltering dollar, the advance fizzled as both the UK and European Union hardened their stance in Brexit talks. EU President Donald Tusk said on Friday that he wants British concessions on the divorce bill by early December.
Risk reversals in sterling reached their most bearish in more than a month on November 15, signalling that option traders are bracing for losses in the currency. Gilt traders pushed down benchmark UK 10-year government bond yields by five basis points last week, with further moves dependent on the budget’s borrowing target.
For currency markets it is less about the tax-and-spend details in the budget and more about the government’s own future strength and the growth outlook, said Stuart Bennett, the head of G-10 FX strategy at Santander GCB. He predicts the pound to fall in the coming week, having failed to break above $1.33 in the London session on Friday.
“It is whether the government gets through the budget without major criticism or without anyone turning on the Chancellor,” Bennett said, adding the budget may highlight political divisions rather than give economic support.
Two ministers have stepped down from the UK cabinet this month, the Foreign Secretary has faced calls to resign, and some officials are under investigation over a sexual harassment scandal in Westminster, hurting the authority of Prime Minister Theresa May. That and mixed economic data have left the British currency heading for its second month of losses, despite the Bank of England’s first interest-rate rise in a decade in November.