Pound-Euro Rate's Steady Climb Extends Following Sunak's 'Giveaway' Budget

- Budget giveaways help support GBP
- But stock market performance now a key driver of GBP value
- UK vaccine advantage to aid economic recovery

Images © UK Parliament/Jessica Taylor

• Market rates at publication: GBP/EUR: 1.1572 | GBP/USD: 1.3954
• Bank transfer rates: 1.1348 | 1.3663
• Specialist transfer rates: 1.1490 | 1.3856
• More about bank-beating exchange rates, here
• Set an exchange rate alert, here

Pound Sterling remains on track to extend higher against the Euro courtesy of a relatively well received 2021 budget, the UK's vaccine advantage and broadly stable global equity markets.

The Pound-to-Euro exchange rate (GBP/EUR) peaked at 1.1598 over the course of the past 24 hours as it attempts to claw back the sharp 1.0% slump it suffered last Friday, a decline that put a massive dent in Sterling's recovery.

However, taking a step back and observing the daily GBP/EUR chart shows the Pound might have been entering overbought conditions towards the end of February and the correction lower at the turn of the month means it has actually fallen back into a more sustainable uptrend:

Technical momentum remains supportive of this stage and only a breach of the above trend line (in purple) would hint at a more notable deterioration in the trend.

Domestic drivers remain supportive of Sterling courtesy of the UK budget announcement that saw the Chancellor of the Exchequer announce an increase in spending, aimed at seeing the UK through to the end of the covid lockdown.

Rishi Sunak told Parliament on Wednesday that spending levels would increase to ensure the post-lockdown recovery was as durable as possible while the tax hikes that were announced were perhaps not as sharp as some press reports had hinted.

"The Budget was more stimulative than expected in the near term, with additional support resulting in a net giveaway of £65BN in 2021/22, equivalent to 3.1% of 2020 GDP," says Samuel Tombs, Chief U.K. Economist at Pantheon Macroeconomics.

Increased giveaways include an extra £6BN in business rates relief and £5BN in grants.

The hospitality and tourism sector received an extension of the 5.0% rate of VAT put in place last year until the end of September, followed by a 12.5% rate in the subsequent six months.

"Sterling has looked strong over the month of February appreciating by 5% against the dollar... although there has been a slight sell off on the way into the Budget announcement. With the markets hungry for an economy that is willing to invigorate growth, post-announcement GBP has risen 0.15% against USD and 0.2% against EUR," says Lee McDarby, CEO of U.K. International Payments at Moneycorp.

"The reality is, with a vaccine rollout well underway, and a Budget that clearly has its eyes on the future, the UK is in pole position to exit the pandemic and begin returning a to new normality – and GBP has reflected this," he adds.

{wbamp-hide start}{wbamp-hide end}{wbamp-show start}{wbamp-show end}

Near-term support to the economy now amounts to £44BN, or 2% GDP, according to the Office for Budget Responsibility (OBR), and means the 2021/22 deficit is projected to stay above 10% of GDP.

However, the reaction of markets and economists alike has been broadly supportive of the Chancellor's decisions.

"For all the recent talk about fiscal consolidation, UK Chancellor Rishi Sunak’s overwhelming priority was always about navigating the economy successfully through what is likely to be a delicate recovery phase. And on the face of it, his budget should go some way to achieving that," says James Smith, Developed Markets Economist at ING.

However the bounce in Sterling exchange rates might have been greater were it not for the Chancellor's decision to raise corporation tax a sizeable 6.0% to 25% in 2023.

The OBR says the planned tax hikes will increase the UK tax burden from 34% to 35% of GDP in 2025-26 which is the highest level since the late 1960s.

"Moving Corporation Tax to 25% in one leap will cause a sharp intake of breath for many businesses and sends a worrying signal to those planning to invest in the UK," says Tony Danker, CBI Director-General. "The UK must remain attractive for every type of business, from the innovation, high-growth UK homegrown firm to the global firms investing in the UK. We look forward to working with the government to achieve this."

The sting of the tax announcement was countered somewhat by the decision to only apply the hike to profits above £50K, meaning some 30% of companies would likely be affected according to Treasury estimates.

While then OBR and Treasury expect the tax increase to raise revenue, economists warn that experience shows raising taxes does not necessarily mean the government will see its receipts increase, as companies who operate in a global market place are able to shift their tax liabilities to protect their bottom line.

"This corporation tax hike is likely to serve as a prompt for businesses to consider their overseas financial options," says Nigel Green, CEO of de Vere Group. "Lower corporation tax helps job and wealth-creating business to survive and thrive. It also helps attract business to move and invest in the country."

"The mixed messaging of more fiscal aid now but a future reckoning to come may leave GBP a little confused about where to go," says Daragh Maher, Head of Research, Americas, at HSBC.

Although the budget has been considered to be supportive from a domestic perspective, the British Pound will struggle to return to winning ways against the Dollar and Euro as long as global stock markets continue to struggle.

The Pound has proven to be highly attuned to global investor sentiment in 2021, thanks largely to the completion of the EU-UK trade deal in December.

"The pound has been behaving more like a risky asset than a safe haven one since the start of the pandemic. Indeed, the correlation between the FTSE 100 and the pound has risen sharply since the start of 2020," says Paul Dales, Chief UK Economist at Capital Economics.

Investors are currently showing heightened nerves to the rise in yields paid on U.S. government bonds, particularly those of ten-year bonds.

Bond yields are rising as investors fear inflation will increase over coming months and years, which means they demand a higher yield to be paid for holding these bonds.

Above: The Pound-Dollar rate (orange) has tracked moves in the U.S. S&P 500 index.

Higher yields mean higher payments must be made by bond issuers and the cost of finances rises more generally.

Not only do rising yields pose headwinds to the recovery but they also offer investors an alternative investment to equities.

Yields fell back and stocks recovered on Wednesday following rumours that the Federal Reserve would address the rise in long-term yields at some point this week.

How these bond market / equity market dynamics play out could be the ultimate decider if 2021's rally restarts.