2% Downside Potential Against Euro and Dollar if Hunt Gets it Wrong

Above: File image of Chancellor Hunt. Picture by Simon Dawson / No 10 Downing Street.

If Jeremy Hunt gets the March 06 budget wrong, the Pound could fall by as much as 2%, but analysts at ING also say there are some positives to look for.

The British Pound has risen from the lows triggered by the debacle of former Prime Minister Liz Truss’s ‘mini-budget’, but analysts at ING Bank say there are still some dangers posed to the currency by the March 06 budget.

ING estimates there’s a 40 basis point risk premium in 10-year gilt yields, “suggesting markets aren’t totally immune to UK fiscal risk”.

Current Chancellor Jeremy Hunt has proven himself a safe pair of hands by returning orthodoxy to UK fiscal decision-making, but this is an election year, and with the Conservatives low in the polls, the temptation to make giveaways must be tempting.

ING estimates that the amount of money available for tax cuts, so-called ‘headroom’, now equals £18BN, up from £13BN in November. But that’s lower than estimates a few weeks ago in light of the repricing of Bank of England rate expectations:

Above: As expectations for interest rate cuts fade, the fiscal headroom available shrinks. Image: ING and Macrobond.

The risk is that the Chancellor announces measures that once again raise questions about the sustainability of the UK’s finances, given the relatively small pot at his disposal.

“Were Chancellor Hunt to misread the mood of gilt investors and cause another upset, sterling would again come under pressure,” says Chris Turner, Global Head of Markets at ING. “Short-term models suggest a 2% sell-off in sterling could happen quite easily were investors to again demand a risk premium of sterling asset markets.”

For now, foreign exchange markets are relaxed ahead of the event with Pound-Dollar implied volatility close to 6% and the FX options market appearing “relatively relaxed about the 6 March UK Budget,” according to ING.

Above: ING’s models suggest the Pound is undervalued against the Euro. Track GBP/EUR with your own custom rate alerts. Set Up Here

“When it comes to FX markets, current market conditions could not be more different than those that prevailed at the height of the Liz Truss debacle,” says Turner. “Back then, GBP/USD implied volatility surged to 18% – similar to spikes seen on the Brexit vote and the Covid shock – and GBP/USD traded as low as 1.05.”

The Pound to Euro exchange rate fell to as low as 1.0774 on the Monday following the mini-budget.

According to Turner, the current quiet conditions benefit Pound Sterling in outright terms: “Sterling has the second-highest implied yields in the G10 space and is the only G10 currency to deliver a positive total return against the dollar this year. Continued investor interest in the carry trade should keep sterling reasonably well bid.”

ING meanwhile tells clients the Pound could also rise on budget day if some market-supportive developments are announced.

“On the positive side for sterling, there is some speculation that Chancellor Hunt is looking at improving incentives for global multinationals to list in the UK or for British savers to direct investments towards UK asset markets as well. These measures probably will not quite extend as far as the US Homeland Investment Act – a major support for the dollar – but should be monitored nonetheless,” says Turner.

ING’s medium-term fair value calculations suggest GBP/USD is some 7% undervalued and that the dollar will roll lower later this year, it holds a forecast for the Pound to Dollar exchange rate to test 1.30 on a 12-month view.

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