UK pre-budget blues and rate cut concerns pile pressure on pound

By Amanda Cooper and Dhara Ranasinghe

LONDON (Reuters) -Traders are growing gloomy on the outlook for the pound, already at its lowest in months, concerned that a long-awaited budget this month will do little to boost Britain's growth prospects.

Options markets show pessimism over the pound is at its highest level since January, when UK government bonds came under pressure, amid fiscal and monetary policy uncertainty.

Much of this reflects expectations for the Bank of England to cut rates, possibly on Thursday, which would reduce returns for savers and investors and mean less demand for sterling.

Meanwhile, finance minister Rachel Reeves this week laid the ground for tax rises in a November 26 budget, flagging "hard choices" to keep Britain's finances on track.

Although sterling is at its weakest against the dollar since April, at around $1.305, and near its lowest against the euro since 2023, at around 88 pence, this is not proving enough of an incentive for investors to buy it.

Markets now reflect a roughly 33% chance of a BoE interest rate cut this month, up from virtually nothing just weeks ago, with another two cuts priced in for the first half of 2026.

"We are still short the pound," said RBC BlueBay Asset Management fixed income CIO Mark Dowding, referring to a bearish bet on the currency, adding: "Reeves seems wedded to a material tax rise, which will hurt growth".

A fiscally tight budget that keeps so-called bond vigilantes at bay but also dampens growth, may lead to more rate cuts.

"Reeves has a difficult tradeoff - fiscal tightening is a negative for growth and confidence is low," said Lloyds currency strategist Nick Kennedy, who thinks the euro could reach 90 pence in coming weeks.

FROM BULLISH TO BEARISH 

Investors have held bullish sterling positions for most of this year. But that conviction has waned as the outlook for the economy and rates has muddied, which is reflected in options markets. 

One-month risk reversals, measuring the difference between the cost of owning an option to buy the pound in the next month and the cost of owning an option to sell it, have fallen to -1.21 percentage points. This is the lowest since January, as the cost of owning a sell, or put, option, has grown relative to the cost of a buy, or call, option. 

"Risk reversals have definitely skewed to the downside," said Derek Halpenny, head of research for global markets EMEA at MUFG, adding this was mostly down to shifting BoE expectations.

Sterling has fallen against the Swiss franc, Chinese yuan and the Australian dollar this month. And while it is up just over 4% against the dollar in 2025, this compares with a year-to-date gain of 9% only two months ago.

Despite the market gloom, implied options volatility, a proxy for trader demand for protection against large swings in the pound to late November, has been subdued.

Although it hit two month highs of 7.2% on Wednesday, that is well below the 10% seen during January's gilts rout and the 20% logged during 2022's mini-budget market crisis.    

Halpenny said this could be because UK officials have tended to drip-feed the budget, lessening the element of surprise on the day and meaning investors are a bit wary about positioning for bouts of volatility when it could come sooner.

And while traders may be gloomy now, if the budget proves to be less restrictive than expected, sterling could gain longer-term, Halpenny added.

"I would view an 'aggressive budget' of tax hikes as sterling-negative from a BoE rates perspective," he said. "But over time, if that is perceived as credible, then that certainly becomes a more supportive source for sterling."

(Reporting Amanda Cooper and Dhara Ranasinghe; Editing by Alexander Smith)