British Pound weakens as UK budget announcement approaches

Selling pressure weighs on the British Pound ahead of the UK Autumn Forecast Statement.
The scale and credibility of the UK's fiscal headroom will be key considerations for investors.
Friday's BoJ decision is expected to keep interest rates unchanged at 1.25%.

Pressure on the British Pound (GBP) ahead of the United Kingdom (UK) Autumn Forecast Statement has pulled the currency down 0.17% against the Japanese Yen (JPY), to around 209.70 in Wednesday's European trading session. Weakness in Sterling is weighing on the cross.

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How Is Pound Sterling Performing Today?

The British Pound (GBP) recorded its weakest performance against the Australian Dollar today. Its percentage changes against the major currencies listed are shown in the table below.

	USD	EUR	GBP	JPY	CAD	AUD	NZD	CHF
USD		0.01%	0.22%	-0.05%	0.03%	-0.03%	1.41%	0.18%
EUR	-0.01%		0.21%	-0.05%	0.05%	-0.05%	1.39%	0.17%
GBP	-0.22%	-0.21%		-0.23%	-0.16%	-0.25%	1.18%	-0.05%
JPY	0.05%	0.05%	0.23%		0.07%	0.00%	1.44%	0.21%
CAD	-0.03%	-0.05%	0.16%	-0.07%		-0.06%	1.37%	0.15%
AUD	0.03%	0.05%	0.25%	-0.01%	0.06%		1.45%	0.21%
NZD	-1.41%	-1.39%	-1.18%	-1.44%	-1.37%	-1.45%		-1.20%
CHF	-0.18%	-0.17%	0.05%	-0.21%	-0.15%	-0.21%	1.20%

Percentage movements between major currencies are displayed in the heat map. Select the base currency in the left-hand column and the quote currency in the top row. To read the British Pound's change against the US Dollar, for instance, start with the British Pound on the left and follow that row across to the US Dollar column. The figure in that cell represents the percentage change in GBP (base)/USD (quote).

Will fiscal headroom determine the gilt response to a cautious UK budget?

Major surprises are unlikely in newly appointed Chancellor of the Exchequer John Healey's first Budget on Wednesday, according to economists at ABN AMRO. In their assessment, “rising debt-servicing costs, with Gilt yields near multi-decade highs, are eroding the Chancellor’s fiscal headroom… but the UK’s high inflation means wage growth is likely to be a crucial offset, making room for a potential positive surprise.” They therefore expect Healey “to prioritise rebuilding fiscal headroom, while balancing targeted tax rises with limited cost-of-living support.”

For ABN AMRO, the key market consideration is that “markets will be most focused on the size and credibility of the headroom that remains after the Chancellor’s budget decisions have been accounted for.” Their central expectation, against a backdrop of “sensitivity in bond markets,” is for Healey to “err on the upper end of credible headroom estimates of around £18-24bn, i.e. something not too far from Rachel Reeves’ last budget.” In assessing the potential market response, they suggest that “the lower bound of a satisfactory figure for markets is probably around the £14-15bn mark,” and warn that “below £14bn, the Chancellor risks a negative bond market reaction,” while “anything close to or above Reeves’ £24bn is likely to result in a positive market reaction.” Although “much of the rise in gilt yields reflects the global repricing of interest rates,” they also flag the risk that “insufficient headroom could add a UK-specific fiscal risk premium on top of this.”

Reviewing the UK's recent fiscal path, ABN AMRO observe that “headroom has been perilously low in recent years as the UK came under increasing fiscal pressure, though Healey’s predecessor Rachel Reeves worked hard to rebuild it.” Their account of the earlier outlook is that “up until recently, headroom was forecast to decline sharply on the back of the jump in interest rates we have seen this year, from £24bn to around £13bn.” Nevertheless, they “see room for a positive surprise, and this is linked to the Office for Budget Responsibility’s (OBR) wage growth assumption,” which underpins their view that Healey will seek headroom “on the upper end of credible headroom estimates of around £18-24bn.”

Although 10-year UK Gilt yields have surrendered their initial gains ahead of the UK budget announcement, they remain 0.18% higher at close to 5.35%.

Next week's monetary policy announcement from the Bank of England (BoE) will be the British Pound's next major catalyst. Expectations strongly favour a 25 basis points (bps) interest rate increase to 4%.

The Japanese Yen, meanwhile, is outperforming its major currency peers as investors await Friday's monetary policy decision from the Bank of Japan (BoJ).

Can December rate-hike pricing support the Yen as the BoJ is expected to hold?

A pause remains the broad expectation for the BoJ, with Brown Brothers Harriman (BBH) analysts saying it is "widely expected to keep rates on hold at 1.25% and assess September’s 25bps hike before tightening again." To illustrate Governor Kazuo Ueda's cautious approach, they recall that "in September, BoJ Governor Kazuo Ueda warned that rapid rate hikes could unsettle asset prices, adding that it could take some time to confirm that 2% inflation is entrenched." Market pricing has nonetheless become more hawkish, BBH observes, noting that "the swaps curve price in 75% odds of a 25bps BoJ rate hike to 1.50% at the December 18 meeting and nearly 75bps of tightening in the next twelve months," a development the analysts regard as supportive for the Yen.