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In short: tactical upside, strategic downside.
The British pound could be set to enjoy a short spell of relief in the wake of the budget, say analysts at Lloyds Bank.
"The budget elicited initial GBP optimism, but it doesn't change the fundamentals," says Lloyds Bank's FX Strategist, Nicholas Kennedy. "The currency implications for the budget look limited short-term."
The pound-euro rose 0.34% on the day to go above 1.14 and GBP/USD rose above 1.32, in line with Pound Sterling Live's warning on budget eve that currency was a "screaming buy" as the "contrarian signals were everywhere".
We said that when the mainstream newspapers start predicting a rout, the opposite tends to happen.
Kennedy expands on the theme:
"To flesh that out a little bit, the weeks of policy leaks frayed plenty of market nerves. The result of that was positioning skewed to managing downside risks for GBP. As unknowns become knowns that automatically generates relief, and some squaring of more apocalyptic type trades."
The below chart, courtesy of Lloyds, indicates that fund managers and investors purchased FX market options to protect against declines in the pound. The newspapers picked up on this as near proof that a rout awaited:
This left the market heavily positioned against the pound, and when positioning reaches crowded levels, it typically requires a significant surprise to trigger further weakness.
"So, the pound's rally during and after the Chancellor's presentation looks reasonable," says Kennedy.
But what comes next, and how far can the rally extend?
According to Lloyds, the budget measures announced Wednesday actually reinforce a lot of the problems faced by the UK economy.
"That ought to reinforce the longer-term negatives that surround Sterling," says Kennedy.
He explains that the overall policy mix announced still looks unhelpful.
Expanded welfare provisions and above-inflation increases to the state pension and the minimum wage (not a fiscal cost, but a government dictate nonetheless) will sustain inflation.
Economists at Lloyds say inflation persistence helped deal with a lot of the productivity downgrade. With no real growth, nominal growth is all the government is likely to get.
"It juices fiscal drag and helps debt sustainability (financial repression). So, cost of living mantra aside, this looks a feature of policy not a bug," explains Kennedy.
The government announced £26.1BN worth of tax rises over the forecast horizon, but most of these land after 2029 as inflation drags salaries into higher tax brackets.
The tax rises will "be a hit to confidence, they’ll add further complications to the tax system," explains Kennedy.
According to analysts, the government also did little to improve the economy's productivity potential, "aside from tenuous assumptions on the impact of planning reforms. So the productive mix is equally problematic."
"The pound looks rich and needs to be weaker to support the domestic economy and downside growth risks," says Kennedy.