Above: Chancellor Rishi Sunak preparing the autumn 2021 budget. Image: HM Treasury UK / Gov.uk.
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The British Pound will take cues from new spending and tax announcements issued by the UK Treasury at midday, with investors keen to establish if there will be a net boost to spending.
The rule of thumb that a stimulatory budget would be supportive of UK economic growth and would therefore offer support to Pound Sterling valuations.
"For sterling, we need to make sure that Sunak’s announcements do not cause markets to reprice their expectations from the near-term Bank of England meetings that have been supporting sterling," says Jeremy Thomson-Cook, Chief Economist at Equals Money.
Ahead of the budget, leaks issued by the Treasury show more than five million public sector workers are set for a salary rise next year as an end to the Covid-era freeze on public sector pay is rescinded.
This will perhaps be the most stimulatory element of the budget announcement as higher pay packets will help underscore consumer sentiment - a key engine of UK economic activity - over the medium-term.
There will also be an increase in the National Living Wage from £8.91 to £9.50 an hour, amounting to an extra £1K a year for a full-time worker and expected to benefit up to 2.5 million people.
In the 24 hours preceeding the budget announcement the Pound rallied to a fresh 2021 high against the Euro and registered advances against all its major peers.
The Pound to Euro exchange rate went as high as 1.1898 while the Pound to Dollar exchange rate went as high as 1.3829.
Above: GBP outperformed peers in the lead up to budget day.
"The British pound hit a new 2021 high versus the euro... in fact, it’s the highest level since the pandemic-induced market turmoil in March 2020," says George Vessey at Western Union Business Solutions.
Vessey says UK bond yields continue to surge with the 10-year yield above 29-month highs, boosting demand for the Pound, particularly against low-yielding currencies like the Euro.
The Pound outperformed even as money market pricing shows the odds of a November rate hike at the Bank of England have eased back somewhat from their recent highs.
Foreign exchange strategists had been warning that such a reversal in pricing would be consistent with a weaker Pound.
But that the Pound hit a new 2021 high against the Euro and went back above 1.38 against the Dollar despite these easing hike expectations suggests that there is more to the Pound than just Bank of England interest rate expectations.
"Month-to-date, sterling is outperforming the euro by about 2%, on track for its second biggest monthly gain in two years," says Vessey.
Budgets don't typically impact the value fo the Pound, but this year's budget comes in an unusual environment and just days before a key decision on interest rates at the Bank of England.
It could therefore offer up some volatility than would typically be expected.
Above: Expectations for a 2021 BoE rate hike are elevated. Image courtesy of CME.
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Numerous spending plans have been leaked by the Treasury to the press over recent days however it won't be possible to gauge if these spending pledges are genuinely expansionary.
This is because many pledges have already been announced and the money is yet to be delivered; only once the details have been assessed will it be known if this is a consolidative or expansionary budget.
"Despite the headline spending pledges dropping prematurely onto newspaper headlines, the details of the budget remain obscure. The Chancellor will be expected to provide more clarity to the House tomorrow and it is therefore possible we see a stronger reaction in GBP over subsequent trading sessions," says Charles Porter, analyst at SGM Foreign Exchange Ltd.
For the Pound the rule of thumb is that an expansionary budget is supportive and a consolidate budget could pose headwinds.
"Our initial thoughts are that this week will not see any major announcement on fiscal consolidation strong enough to prompt a more dovish re-pricing of the BoE cycle," says Chris Turner, Global Head of Markets and Regional Head of Research for UK at ING.
An expansionary budget - particularly one that contains rising wages - could impact decision making at the Bank of England which is concerned about increasing wage pressures.
The Bank looks set to raise interest rates once in 2021 and again in 2022 amidst concerns that rising inflation caused by energy prices and supply chain squeezes will feed into other sectors of the economy.
Of particular concern is that inflation expectations rise and lead to higher wage settlements, which in turn stimulates inflation further.
That the government has dropped the public sector pay freeze in view of rising inflation is a clear example of how rising inflation expectations begets further inflationary pressures.
Andrew Sentance, Senior Adviser to Cambridge Econometrics says since 1700 UK public debt has averaged around 95% of GDP.
The latest figures from the ONS shows it is currently 95.5% and the interest cost of servicing that debt is very low.
"So let’s not fall for any budget rhetoric about the urgent need to reduce debt levels," says Sentance.
The Budget, Fast Facts:
The following pointers come courtesy of Kallum Pickering, Senior Economist at Berenberg.
- Public sector borrowing has come in lower than projected by the Office for Budget Responsibility back in March
- Government may borrow around £150bn for fiscal year 2021-22
- This would be well below the £234bn projected in March
- The fall would reduce borrowing as a % of GDP for this year from 10.3% (March projection) to around 7%
- This would then likely fall to around 3% or lower by the middle of the decade
- "We do not expect the chancellor to announce further economically significant tax increases"
- "On the expenditure side, we do not look for any game-changing announcements"