Picture by Kirsty O'Connor / Treasury
Pound sterling could see heightened volatility in the coming hours as the government announces its 2025 budget.
With the Chancellor, Rachel Reeves, needing to find approximately £30BN in taxes to meet her fiscal rule and restore some breathing space, the UK economy faces a momentous day.
The FT calculates workers currently earning £50K a year, the 70th percentile of full-time UK employee wages, will see the share of their income that goes in income tax and national insurance payments increase by 1.5 percentage points by 2029-30.
The Times says the tax raid will rely on a two-year freeze of income-tax thresholds, which will hit millions of workers and pensioners, and a tax raid on pension contributions.
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Also, look out for a reduction in the amount of money that can be saved tax-free each year in a cash ISA, from £20K to £12K.
A charge on properties worth more than £2M is also expected, as is a pay-per-mile scheme that will target electric cars.
Above: GBP/EUR at monthly intervals.
Our immediate concern is that these efforts won't raise what is needed and the market will worry about the UK's economic outlook and the government's ability to stay on top of its budget.
? If this happens, the pound can come under pressure today; any misstep will be punished by a market worried that the government simply is unable to restore fiscal credibility.
? "The risks to the pound perceived by the market are more likely to materialise this year than last year, given that conditions have deteriorated and the government does not appear to have a convincing plan," says Michael Pfister, FX Analyst at Commerzbank.
That being said, the prospect of a big Liz Truss-style blowup is limited as such spectacular market moves rarely happen when everyone expects them to. And that's the point: the Treasury knows the best chance of avoiding a market meltdown is to leave nothing to surprise.
Pound Sterling Live's lead on Tuesday was that the pound was, in fact, a buy, as contrarian signals were everywhere.
There's an element of shutzpah in making such a call, and we acknowledge and warn readers that there's still a non-negligible risk of the pound falling by a significant amount.
But the reason we're not convinced that the pound faces a crisis-style collapse is the open doors at the Treasury:
"It seems that officials, with their multitude of ideas, some of which were subsequently cancelled, failed to convince pound investors," says Pfister.
€ The steady leakage of plans has weighed on pound sterling over recent weeks, leaving pound to euro exchange rate (GBP/EUR) down 1.70% in Q3 and a further 0.70% lower already in Q4. ?For the pound to dollar exchange rate (GBP/USD) it's 2.09% and 1.10%.
Yet, the currency rose across the board on Tuesday, which tells us that much of the bad news associated with the budget are likely in the price and much of the budget adjustment is behind us.
Looking ahead, the dissipation of economic uncertainty could see some of the recent risk premium absorbed by sterling exchange rates disappear.
? If so, GBP/EUR can edge north of 1.1450 again. GBP/USD could solidify itself above 1.32.
However, we continue to agree with those who view GBP strength as being tactical, i.e. lasting in the short term, ahead of a continuation of the broader trends lower.
This means we could see GBP gains into year-end, ahead of another difficult year for the currency, particularly if today's budget measures contribute to falling inflation.
Sure, easing inflation will be welcomed by households and businesses, but it would also encourage the Bank of England to cut interest rates further and faster.
This would weigh on British bond yields and the pound, as is traditionally the case.