Sterling Heads Into October With The Budget Looming

As we head into October, I think the biggest domestic risk facing Sterling over the next month is becoming fairly clear: the UK Budget on 28 October.

The Pound has already started to come under some pressure, with GBP/EUR falling back towards the lower end of its recent range and GBP/USD also losing ground. There are obviously other factors involved, particularly the renewed strength of the US Dollar, but I think we are now entering a period where concerns around the Budget are going to become increasingly important for Sterling.

The difficulty for the Government is that the public finances do not leave the Chancellor with much room to manoeuvre. August borrowing came in at £18.3bn, around £3.5bn higher than the OBR had forecast, while borrowing for the financial year so far is now £8.1bn above forecast. At the same time, higher government borrowing costs have reduced the amount of headroom available against the fiscal rules.

That becomes particularly relevant when we consider some of the measures currently being discussed ahead of the Budget. There has been speculation around further support with household energy costs, changes to personal taxation and additional spending commitments. Any of those measures ultimately have to be paid for, either through higher taxes, spending reductions elsewhere or additional borrowing.

For currency markets, I think the important distinction is between the build-up to the Budget and the announcement itself.

We saw something similar last year, where Sterling came under pressure as we approached the Budget and markets tried to price the various rumours around tax, spending and borrowing. Once the announcement actually arrived and markets had something concrete to work with, much of that uncertainty disappeared and the Pound was able to recover.

I think there is a reasonable chance we see a similar pattern this time.

Between now and 28 October there will inevitably be headlines about potential tax rises, spending commitments and how much fiscal headroom the Chancellor actually has. Some of those stories will prove accurate and others probably won’t, but markets generally dislike that uncertainty. I therefore wouldn’t be surprised to see Sterling remain vulnerable through parts of October, particularly if concerns around government borrowing continue to build.

My base case, however, is not that the Budget itself causes a major Sterling sell-off. The experience of recent years has made successive governments very aware of how quickly the gilt and currency markets can react when they lose confidence in the UK’s fiscal position. Provided the Chancellor presents measures that are properly funded and maintains credibility around the fiscal rules, there is every chance that some of the pressure building ahead of the announcement begins to unwind afterwards.

Of course, that view comes with an obvious risk. If the Government announces significantly more spending or tax reductions without convincing markets how they will be funded, the reaction could be very different. With borrowing costs already elevated, there is considerably less tolerance for fiscal surprises than there might have been several years ago.

For now, though, I see the Budget more as a source of uncertainty for Sterling throughout October than something we should automatically expect to produce a major negative reaction on 28 October itself. If anything, the bigger opportunity could come from Sterling weakening as we approach the event and then recovering once markets finally have some clarity.

Before we get there, however, we have another week of economic data to work through, taking us from the end of September into the beginning of October.

Monday begins with the minutes from the Bank of Japan’s latest meeting, following its decision to raise interest rates to 1.25%. Markets are already looking towards the possibility of another increase before the end of the year, so the minutes will be useful in showing how much support there is within the Bank for continuing to tighten policy. Given the Yen’s reaction to the September hike, any indication that policymakers are becoming more comfortable with further increases could be important for JPY.

We also have speeches from both Bank of England and Federal Reserve policymakers throughout Monday. I’m not expecting these to be major market-moving events, particularly so soon after both central banks made their September decisions, but any comments around inflation or the likelihood of further tightening will still be worth watching.

Tuesday brings the Reserve Bank of Australia’s latest interest-rate decision, where a 25-basis-point increase to 4.60% is expected. Much of that move is already priced into the market, so I think the press conference will probably be more important than the decision itself. As we have seen with several central banks recently, markets are increasingly interested in what comes next rather than a rate move they are already expecting. Any indication that the RBA is considering further tightening before the end of the year could therefore have a greater impact on the Australian Dollar than the 25-basis-point increase itself.

Closer to home, we also get UK consumer-credit and mortgage-approval figures. Mortgage approvals are expected to have increased last month, which would be an encouraging sign that activity in the housing market is continuing to hold up despite borrowing costs remaining relatively high. Eurozone consumer-confidence data is also due, with another relatively weak reading expected.

Wednesday should be more interesting for Sterling, with the latest UK GDP figures. Quarterly growth is expected to slow from 0.6% to around 0.4%, although the annual growth rate is expected to improve. A slowdown would not necessarily be a major concern on its own, particularly after some stronger UK data recently, but a meaningful miss could add to the pressure already building on Sterling as markets begin looking towards the Budget.

Later in the day attention moves across to the US, with Core PCE inflation, the Fed’s preferred measure of underlying inflation, alongside other US economic releases. With the Federal Reserve having just raised rates, inflation remains particularly important. The question now is whether September’s hike was enough, or whether the data continues to support the case for another increase before the end of the year. A hotter PCE reading would inevitably strengthen the latter argument and could provide further support for the Dollar.

Thursday is predominantly a PMI day, with manufacturing figures from the Eurozone, UK and US. As usual, markets will be looking at whether activity remains above or below the 50 level that separates expansion from contraction. We also have Eurozone unemployment and the latest US weekly jobless-claims figures, giving us another look at the labour market before Friday’s much more important release.

That brings us to Non-Farm Payrolls.

Current expectations are for around 100,000 jobs to have been added, down from 162,000 last month. As always with NFP, I wouldn’t put too much weight on the forecast itself because this is one of the more unpredictable releases on the calendar.

Last month was a good example of why the headline number also needs to be treated carefully. The 162,000 increase initially looked very strong, but a significant proportion of the jobs came from hospitality and government, while wage growth softened. This month I’ll therefore be paying just as much attention to where the jobs are being created, unemployment and wages as I will to the headline number.

A significantly stronger report would reinforce the idea that the US economy can withstand higher interest rates and could increase expectations for another Fed hike before the end of the year. A weak report, particularly if accompanied by softer wages or higher unemployment, would make that argument considerably more difficult.

Overall, this week gives us plenty to work with, but I still think the bigger story for Sterling throughout October will be the Budget rather than any individual economic release.

That does not necessarily mean I am bearish on the Pound for the rest of the year. In fact, my view is more nuanced than that. I think the uncertainty surrounding the Budget could create periods of Sterling weakness as we move through October, particularly as speculation around tax, spending and borrowing intensifies. If the eventual announcement is credible and avoids any major fiscal surprises, however, that uncertainty disappears very quickly.

We saw a version of that pattern last year, and I would not be surprised to see it again. For anyone with a significant Sterling requirement over the next couple of months, the important thing may therefore be distinguishing between weakness caused by a genuine deterioration in the UK outlook and weakness caused simply by markets becoming nervous ahead of 28 October.

For now, we start the week with the BoJ and finish it with US employment, but as September turns into October, I suspect the UK Budget will increasingly become the story that matters most for the Pound.

Subscribe now