Chancellor Rachel Reeves ahead of the Budget, in No 11 Downing Street. Picture by Kirsty O'Connor / Treasury.
Analysts at Nomura say major tail risks associated with this week's budget have been avoided, even if questions remain.
The near-term direction of the pound-to-euro rate turned higher on Wednesday as investors reacted to 2025's budget, judging it reduced immediate fiscal risks.
Sterling held gains against the euro after the government secured an additional £22BN in fiscal headroom, easing pressure on UK borrowing concerns and supporting currency sentiment.
EUR/GBP traded softer to 0.8753 by Thursday morning as markets unwound short sterling positions that had been built ahead of Budget 2025. GBP/EUR rose to 1.1420.
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Dominic Bunning, FX strategist at Nomura, said the budget "avoided the major tail risks that could have hurt GBP" because the government increased its fiscal headroom while sidestepping any near-term tightening that would have weighed on growth.
He said Nomura closed its long EUR/GBP trade at 0.8760 “for a gain of 0.6 percent”, noting the position had been opened on 19 September at 0.8710.
He said "short GBP positions had been popular going into the budget, and these are likely to see some unwinding" now that the event had passed without negative surprises.
He said this reaction "could see EUR/GBP break some recent support levels" as positioning adjusts.
Above: The converse of EUR/GBP breaking support is GBP/EUR breaking resistance levels.
The pound’s recovery followed a cautious welcome from markets after the Office for Budget Responsibility cut growth forecasts by a limited amount, allowing tax increases and spending plans to meet the government’s fiscal rules.
Analysts said the modest downgrade signalled a more favourable starting point for the government’s fiscal strategy than investors had expected.
However, Bunning cautioned that the back-loading of fiscal tightening into 2029 to 2031 could still prompt "scepticism about whether they will ever be delivered", implying that fiscal credibility risks were not fully removed.
Another potential headwind for pound sterling is that the budget could raise the odds of a Bank of England interest rate cut.
Nomura says new budget measures could shave “around 0.3 to 0.4 percentage points off headline CPI over the next fiscal year”, potentially encouraging markets to price further Bank of England rate cuts.
Bunning says disinflationary effects from the budget might keep BoE expectations fluid in the months ahead.
Nomura strategists retains a conviction score of two out of five on the trade and would watch for opportunities to re-enter when market positioning becomes “less stretched”.
Following the budget, the broader market reaction remains consistent with a view that fiscal concern had eased for now.
The pound also rose against the dollar as investors digested the updated forecasts and the absence of new near-term tightening measures.
HSBC said it expected the pound to strengthen if the budget continued to meet what it called a credibility threshold.
Traders said the softer euro and steady pound pointed to scope for further near-term pound-to-euro recovery as investor positioning resets after the budget.