Sterling Surges to 18-Month Highs as UK Budget Approaches and Markets Respond
Market Dynamics and the Upcoming UK Budget
By Mike Dolan
LONDON, Oct 22 (Reuters) - Sterling is roaring into next week's UK budget, marking a dramatic change in mood from last year's trepidation and emerging as an eye-catching performer in otherwise nervy global markets.
Political Changes and Global Perceptions
A change of political leadership in the interim may be the obvious difference from 2025. But a world more anxious about sovereign debt and tech-sector bubbles may now view Britain as a way to sidestep the worst of potential fallout.
Interest Rate Horizons and Currency Movements
Shifts in relative interest rate horizons provide the simplest explanation for sterling strength, which is now probing 18-month highs against the euro and its best levels against the dollar in over four weeks.
Surprisingly brisk UK growth, employment and inflation mean another quarter-point rate hike has been added to the market's one-year Bank of England outlook over the past month, just as French debt tensions and the threat of euro zone contagion have lopped a quarter point off the European Central Bank view over the same period.
The Federal Reserve's outlook is basically unchanged over the past month.
But it's a punchy currency move nonetheless. Over the space of a month, sterling has risen almost 2.6% against a euro weighed down by French political angst and debt worries, but it also gained about 1% against a far more buoyant US dollar.
While the premium on 10-year UK gilt yields over Germany has risen about 25 basis points in that time to nearly 2 percentage points, the gilt premium over French 10-year debt has halved to just 37 basis points. UK stock indexes are up about 1%, too.
Comparing to Last Year’s Budget
Contrast that with former finance minister Rachel Reeves' final budget in late November last year, when fears over tax and borrowing plans had the pound, gilts and the FTSE equity benchmark all under pressure for weeks.
Twelve months on, much has changed, not least the change of Labour prime minister in July, from Keir Starmer to Andy Burnham, and a change of finance minister from Reeves to John Healey.
At the very least, the change at the top has transformed the government's opinion poll ratings - and that fact alone provides a major contrast to other European and US leaders.
Global Events and Their Impact
But most dramatically this year, the Iran war has shocked energy markets and upended inflation and interest-rate policy, potentially putting Britain back in the same boat it was in last year.
Yet as Healey prepares to unveil another difficult budget next week, struggling to keep spending within the government's own fiscal rules, he faces a very different market backdrop.
Aided by a relatively tight fiscal stance, the BoE has so far held the line on interest rates this year despite hikes at the ECB and Fed. The economy has held up impressively and is one of the fastest-growing in the Group of Seven (G7) nations.
It appears Healey is intent on not rocking that boat.
The Budget Outlook
Expectations for a “Mercifully Boring” Budget
MERCIFULLY BORING BUDGET?
Deutsche Bank economist Sanjay Raja brands it the "Do no harm" budget, with limited tax and spending moves flagged in advance despite the narrow room Healey has to manoeuvre.
Raja says the "low-key" affair will still matter for markets, with stability critical before much tougher government spending reviews next year.
"A dull Budget need not be an unimportant budget," he wrote.
Market Sensitivities and Economic Data
Goldman Sachs senior UK economist James Moberly flagged higher borrowing projections given shifts in interest rates and gilt yields over the year, making it more important to avoid disturbing markets or the economy.
And on that score, the latest UK data sweep on Wednesday seemed jarring at first. British inflation and borrowing rose more than expected last month, with total government debt topping £3 trillion ($4 trillion) for the first time.
The numbers also underlined why Britain looks relatively solid in a world of scarier sovereign debt metrics.
Debt, Deficit, and International Comparisons
Despite higher borrowing than official forecasts made before the Iran war, the budget deficit for the first six months was more than £4 billion lower than last year, and the debt-to-GDP ratio is lower than 12 months ago, thanks to faster growth.
At just over 100% of GDP, Britain's debt load and servicing costs are burdensome, but they are lower than those of France and the US. And while Germany's debt burden may still be lower, it's fast converging on British levels after a recent defence spending splurge.
As ING's James Smith points out, Britain is one of the few major economies that's actually managing to rein in government finances at the moment, helping stay the BoE's hand. If growth is improving, then that starts to resonate.
"Britain gets a bad rap on its public finances, but they're in better shape than many other developed economies right now," he said. "The UK is the only G7 economy currently doing fiscal consolidation."
Political Risks and Election Uncertainty
A long list of risky elections crowds the calendar over the coming year: US midterm elections, a snap election in Spain next month and French elections next April. Britain's more popular government and hefty majority may seem a calmer berth against all that.
The only fly in that ointment is that Burnham sees the economic picture and polls as good enough to allow him to seek a popular mandate for his role in Number 10 Downing Street by calling a snap election next year.
ING's Smith thinks that could upset markets again by introducing policy uncertainty, whether Labour wins or loses.
That decision is likely to wait until 2027, however, and Healey's boring budget may just be what the doctor ordered in the meantime. Britain might actually look relatively good for a change.
Conclusion
(The opinions expressed here are those of Mike Dolan, a columnist for Reuters.)
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