There has been no respite for the pound today, as it takes another dip ahead of the Chancellor’s Budget announcement at 1230 GMT. But could it be sell the rumour, buy the fact for sterling today?
We expect sterling to tread water with a bearish bias as we lead up to the Budget, after all, the contrasting fiscal stances between the UK and the US is decidedly pound negative. However, if the Chancellor manages to avoid terrifying the market with his continued push for austerity and instead focuses on a positive fiscal outlook for the UK – with borrowing down and tax take up – then the pound and Gilt yields could stage a mini recovery on the back of Hammond’s speech.
Ahead of the Budget, the technical picture is decidedly bearish for the pound. For GBP/USD a break below 1.2180-90 – a weekly support level that has not yet been tested on a weekly basis – would be a negative development for GBP/USD and could trigger a fall towards 1.20.
What happens when GBP/USD gets to 1.20?
1.20 is a major line in the sand for cable, and below here is considered no-man’s land. While we predicted that the budget could knock the stuffing out of sterling, it appears that the bulk of the selling has happened ahead of the Budget speech. Read our preview here: https://www.cityindex.co.uk/market-analysis/forex-news/40127262017/will-the-uk-budget-knock-the-stuffing-out-of-brexit/.
Why a break below 1.20 may not be on the cards today
We don’t think that today’s Budget will be enough to trigger a full-blown break below 1.20 for cable. After all, the Chancellor has two full Budgets this year and this one is likely to be short on drama as we lead up to the triggering of Article 50 later this month.
UK-US yield spread at record low
The trigger for a test below 1.20 is likely to come from the UK-US yield spread, the 10-year yield spread currently stands at -133 basis points, its lowest ever level. If this spread continues to widen to the downside, possibly towards -150 bps, then it’s a near certainty that the pound will fall below 1.20 and stay there for some time. Whether or not we get to this level will depend on next week’s FOMC meeting, in our view. If the Fed hikes interest rates this month and then suggests that a rate hike in June is a possibility, then we may see the UK-US yield spread fall even further into negative territory and drag the pound down with it.
It’s all about the data, the data, the data…
While sterling may stage a recovery post-Budget, there are plenty of factors that could weigh on the pound in the future. Other themes that could hurt sterling aside from the contrasting fiscal stance of the UK and the US and the FOMC rate hike, is the triggering of Article 50, which is expected to take place by the end of this month. Although the House of Lords failed to pass the Government’s Brexit bill (again) on Tuesday, we believe that the impact on sterling from the Lords defeat is small. Of more concern is the slowdown in UK economic data, which has been disappointing market expectations’ since mid-February. If this continues then it could be curtains for the predicted recovery in the pound this year.