Sterling set for biggest four-week drop in a year before UK budget

LONDON (Reuters) – The pound stayed on track for its biggest four-week decline in over a year on Friday, albeit it steady on the day, as investors cling to the dollar in choppy political and macroeconomic waters.

Sterling traders are also preparing for the new Labour government’s first budget on Oct. 30.

Finance minister Rachel Reeves on Thursday confirmed she will change the measure of public debt that the government targets in next week’s budget to allow for billions of pounds more in borrowing for investment, she said on Thursday.

The news pushed up gilt yields on Thursday, but did little to support the pound.

Sterling was last flat on the day at $1.2982, having traded at two-month lows on Wednesday. So far this week, it has fallen 0.5%, bringing its losses over the last four weeks to 3%, the most since September 2023.

The statement is the latest in a series of indications from Reeves about how she wants more flexibility to borrow to finance investment within the government’s budget rules, but with appropriate guard rails to avoid unsettling investors.

From a financial market perspective, this is a high-stakes budget, and one that could have big ramifications for financial markets,” XTB research director Kathleen Brooks said.

Reeves needs to convince markets that the change she has introduced to the debt rule will deliver growth benefits, or the UK bond market could get spooked, Brooks said.

The backdrop to this budget is one of a weakening pound and rising bond yields,” she said, noting the 3% drop in the value of sterling in the last month, while 10-year gilt yields have risen around 30 basis points to their highest since early July.

More room to borrow means the government could increase gilt issuance, which has weighed on that market.

The premium investors demand to hold 10-year UK debt rather than German – viewed as some of the safest bets in the world – has widened to almost 200 basis points, around the widest in 14 months.

From an FX market perspective, what matters is whether any gilt underperformance turns into uncontrolled volatility. Given the pound is pricing in no risk premium, the downside risks for the currency would be very large,” ING strategist Francesco Pesole said in a note.

Adding to the slightly downbeat sentiment in the pound were surveys on Thursday that showed UK business activity was weaker than expected in the early part of this month.

(Reporting by Amanda Cooper; Editing by Hugh Lawson)