- Despite the continued decline in the GBP/USD pair, which has reached its lowest level in over two months at 1.2907, the British pound may benefit from an expansionary budget in the coming months.
- Pantheon Macroeconomics suggests that the British government will introduce a "more flexible fiscal policy" in its October 30 budget, which will boost GDP by 0.5% in 2025/26.
Robert Wood, chief UK economist at Pantheon Macroeconomics, says, "As a result, the Monetary Policy Committee will need to keep the bank rate 25 to 50 basis points higher than it would otherwise have done."
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The findings run counter to popular expectations that the budget will be austerity-heavy and weigh on UK economic output, which analysts see as a headwind for sterling. Sterling enters the budget as one of the best performing major currencies in 2024 due to the Bank of England’s cautious approach to interest rate cuts amid better-than-expected economic data in the first half of the year. A well-received budget and the Bank’s steady rate-cutting approach could support sterling’s outperformance, particularly against the likes of the euro and other European currencies.
The analyst explained that while the October 30 budget will include significant tax increases, Chancellor Rachel Reeves is generally expected to ease fiscal policy, boost growth and keep interest rates higher than they would otherwise be. Also, Pantheon believes Chancellor Reeves will increase government borrowing by £17.2bn a year – 0.5% of GDP – to support the government’s aggressive day-to-day spending plans.
Meanwhile, the extra spending will be covered by tax increases, but the Chancellor will borrow extra to fund investment. Accordingly, based on the Bank of England’s economic model, a 0.5% growth boost would require the Bank to set its bank rate around 50bps higher in 2025/26 than it would otherwise.
Stronger growth and higher-than-expected interest rates are supporting sterling.
Wood's assessment of the budget contrasts with the current sense of unease growing ahead of the budget statement on October 31, which is expected to see significant tax increases. According to analysts at Pepperstone, "The most significant risk to the bullish view for sterling remains the fragile fiscal outlook here in the UK, as the October 30 budget is likely to see a rather toxic mix of large tax increases and spending cuts." This cocktail, if as radical as current media reports suggest, risks stifling economic growth, which could force the Bank of England to shift gear.
Moreover, If the economy slows as a result of government pressure, inflation could fall faster than previously expected. In response to the slowing growth and lower inflation, the Bank of England will step up the pace of interest rate cuts. Daraj Maher, forex analyst at HSBC, says, "The momentum of the pound's decline against the US dollar will depend on the Bank of England's defensive shift. The UK budget on October 30 clouds the outlook, but tax increases pose a risk to growth and the pound."
Technical forecasts for the GPB/USD pair today:
Today’s GBP/USD will be influenced by the release of manufacturing and services PMI readings for both the UK and US, as well as new comments from the Bank of England Governor. Before that, the general trend of the GBP/USD pair remains bearish. As we mentioned before, stability below the psychological level of 1.3000 will strengthen the bears’ control over the trend. From the support of 1.2870, the technical indicators will move towards strong oversold levels. As mentioned before, there will be no first break of the downtrend without stability above the resistance of 1.31500 again.
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