By Medha Singh

(Reuters) – The British pound firmed on Thursday a day after new UK finance minister Rachel Reeves announced a tax-and-spend budget, leading to concern about inflation and fuelling expectations of fewer interest rate cuts from the Bank of England.

Sterling firmed 0.2% to $1.29870 after falling 0.4% a day earlier. It advanced slightly against the euro at 83.655 pence.

Reeves announced the biggest tax increases since 1993 in her first budget on Wednesday as she sought to repair Britain’s public services, and she also changed the government’s fiscal rules to increase borrowing for long-term investment to boost the economy.

The Office for Budget Responsibility (OBR), whose forecasts underpin British government budgets, now expects inflation will average 2.6% next year, compared with a previous 1.5% forecast.

While money markets see an 80% chance that the BoE will cut interest rates by 25 basis points at its Nov. 7 meeting, traders are now betting on fewer than four rate cuts over the next year from nearly five quarter-point reductions before the budget.

Reeves said her Labour government had more plans to boost the economy and she hoped to not have to hike taxes again.

“This was a big fiscal event – and the headroom for more is narrow,” Bruna Skarica, chief UK economist at Morgan Stanley said.

“In net terms, the event was a bit more BoE-hawkish than we expected, but the scale of the market reaction post the release of the OBR’s EFO seems a bit excessive to us.”

The bond market reaction was more pronounced with short-dated British government bonds extending Wednesday’s selloff.

Sterling was set for its biggest monthly decline since September 2023 as investors adjusted portfolios to price out chances of larger U.S. interest rate cuts, thereby boosting the dollar.

A more gradual easing cycle by the BoE relative to its U.S. and European peers has supported the pound for much of this year.

Conflict in the Middle East also dented some appetite for the pound, which is seen as a more volatile currency than the euro or the yen.

(Reporting by Medha Singh; Editing by Amanda Cooper and Hugh Lawson)