Sterling slips as UK's fiscal hole brought into focus

LONDON (Reuters) -The pound slipped versus the dollar and the euro on Tuesday as the UK's fraught fiscal backdrop was brought into stark focus again, ahead of next week's Bank of England meeting and a closely-watched budget just one month away.

Britain's budget watchdog is expected to cut a key productivity forecast by a larger-than-expected 0.3 percentage points, people familiar with the situation said, potentially leading to a 20 billion-pound ($26.8 billion) hit to the public finances.

At 1232 GMT, the pound was 0.24% lower at $1.3298, making it the worst-performing major currency against the dollar of the day. It was also weaker against the euro, which rose 0.3% to 87.6 pence.

Francesco Pesole, FX strategist at ING, said the trigger for sterling weakness was news of the Office for Budget Responsibility's plan to cut its productivity forecast by 0.3 percentage points.

"That automatically widens the fiscal hole that (finance minister Rachel) Reeves needs to fill with the Autumn budget," he said.

The gilt market, meanwhile, held fairly steady, with 10-year yields trading just below 4.4%.

The countdown is on ahead of Reeves's budget on November 26 with both tax rises and spending cuts on the horizon.

Meanwhile the Bank of England (BoE) is expected to keep interest rates at 4.00% at its November 6 meeting, and a small majority of economists polled by Reuters now expect no further policy easing this year.

Traders are still pricing in a 35% chance of a BoE rate cut at the next meeting and money markets show they believe the base rate will be some 20 basis points below the current 4% level.

"I don’t think the market thinks that ahead of a critical budget, the Bank of England will show its hands. It'll probably want to digest the information first and then start cutting next year in about February," Kamal Sharma, Senior FX Strategist at Bank of America, said.

The pound came off a peak of $1.3787 in July but remains up 6.4% versus the dollar in 2025.

The euro briefly hit its highest level against the pound since May 2023 in early trading before paring some of those gains.

"The pop above the 87.5 level probably saw a few stops being run," said Michael Brown, senior research strategist at Pepperstone, which he said exacerbated the brief spike.

"The lack of follow-through behind that move is not only notable, but will likely also worry the longs a little. Really needs a break above 87.7 to get the move motoring a little more," he said.

(Reporting by Lucy Raitano in London; editing by Amanda Cooper and Andrew Heavens)