Today’s long awaited Autumn budget was a damp squib for FX markets given that the majority of the fiscal pledges were announced in advance of the formal unveiling. Receiving a slap on the wrists from the House Speaker prior to outlining the full budget for giving too much away in advance, the Chancellor went on to outline a net spend of around £30bn a year, as estimated by the Office for Budget Responsibility. However, with inflation concerns and fiscal conservatism top of mind, the net spend was minimal in relation to the £65bn increase in tax receipts that is expected – a £50bn windfall from higher growth and inflation trajectories and £15bn from the rise in national insurance and dividends tax that are due to take effect next year.
The net impact of today’s budget is lower bond issuance going forward, with the OBR now projecting £154bn less in borrowing over the following 5-years.
However, while this news translated into lower bond yields across the Gilt curve, the FX impact was limited. This is because it was the consensus view that Sunak would look to shore up the public finances in today’s budget and Gilt yields would likely drop in him doing so, which resulted in pre-emptive pricing in GBP crosses. While the move lower in Gilt yields was extended once the OBR’s projections were released, the damage had already been done in the FX space from the outset.
UK borrowing profile flattens as the OBR upgrades inflation and growth outlook while downgrading its assumption of economic scarring
While economists scour through the OBR’s extensive November publication in order to gauge the impact of fiscal policy on growth and inflation over the medium-term, FX markets are set to look to the next event; the Bank of England next week.
Money markets have become increasingly less confident that the BoE will raise rates by 15bps at next week’s meeting, and the prospect of a fiscal cliff as of next year is likely to cool expectations further at the margin. The Bank’s current 5.9% growth projection for 2022, in line with the OBR’s 6% forecast, remains on the more optimistic side of the spectrum. This is especially the case with the 4.4pp decline in the cyclically-adjusted budget deficit in 2022-23 that is expected. Given the fiscal withdrawal and money market expectations still remaining somewhat elevated for a rate rise next week, risks are skewed towards the BoE under delivering next week, which may weigh on the pound further given front-end rates have remained a supportive factor of late.
Rishi Sunak may breathe a sigh of relief should the BoE signal a more gradual normalisation cycle than markets are currently pricing. Throughout the budget speech, concerns over rampant inflation and higher interest rate payments were abundant. This is arguably the reason why the fiscal headroom was banked for later use by the Chancellor, especially given the restrictive new fiscal rules outlined in the charter of budget responsibility.
These fiscal rules aim to accomplish the following in three years’ time:
- Underlying public sector debt must be falling as a percentage of GDP
- Everyday spending must be paid for via taxation (current budget surplus)
Should interest payments not balloon and the Chancellor remain on track to achieve his latest fiscal targets, a reversal in planned tax hikes is likely ahead of the next planned general election in May 2024. The likeliest to be scrapped is the planned corporation tax hike from 19% to 25% planned for 2023.
GBP unimpaired by the budget despite Gilt yields extending their decline lower
Author: Simon Harvey, Senior FX Market Analyst