British Pound and Budget 2018: U.K. Economic Growth Forecasts Upgraded but GBP to Remain Under Pressure Near-Term against EUR and USD

Above: Chancellor Phillip Hammond delivers budget 2018. Image © Pound Sterling Live.

- Budget expected to be neutral for the Pound

- Growth forecasts upgraded

- Tax cuts brought forward

- Pound-to-Euro exchange rate @ 1.1254, Pound-to-Dollar exchange rate @ 1.2820

The British Pound was seen drifting lower against the U.S. Dollar but treading water against the Euro after foreign exchange markets opted to delay until after Brexit what should be the positive impacts of a 'growth' budget by the U.K.'s Chancellor of the Exchequer.

The UK’s cyclically‑adjusted budget deficit (budget deficit adjusted for the economic cycle) is projected to widen from 1.3% of GDP in 2018‑2019 to 1.6% of GDP in 2019‑2020.

According to analysts this increase in fiscal expenditure should provide some tailwinds to the economy and we believe bodes well for Sterling in 2019.   

Chancellor Phillip Hammond announced to Parliament that U.K. economic growth forecasts for 2019 and beyond have been upgraded by the Office for Budget Responsibility from the 1.3% forecast announced in March to 1.6%.

The forecasts for subsequent years are as follows:

2020 1.4 (vs. 1.3 previously)
2021 1.4 (vs. 1.4)
2022 1.5 (vs. 1.5)
2023 1.6

Furthermore, the OBR reports that real wage growth should be expected over the coming five years; this bodes well for Sterling long-term as higher wage expectations are likely to generate higher interest rates at the Bank of England which in turn tends to command a stronger Pound.

Despite the upgrades, we believe Sterling is likely to retain a soft bias over the near-term.

"GBP markets will want to see convincing evidence of a soft Brexit landing before chasing any upward growth revision. The UK economy isn't that bad and the tailwind of this + reduced Brexit uncertainty could be a powerful boost for GBP in 2019. Too early to price this story," says Viraj Patel, a foreign exchange strategist with ING Bank N.V.

We don't see the budget playing a large part in Sterling's movements today and coming days and expect Brexit headlines and external currency dynamics to remain in charge.

On the topic of borrowing, it is expected that borrowing this year will be £11.6bn lower than forecast in March at just 1.2% of GDP; it is then set to fall from £31.8bn in 2019/2020; to £26.7bn in 2020-21; £23.8bn in 2021-2022; £20.8bn in 2022-2023’ and £19.8bn in 2023-2024, its lowest level in over 20 years.

According to Samuel Tombs with Pantheon Macroeconomics, "the Chancellor tried to skirt around it, but his new projections show public borrowing set to be higher next year than in 2018/19. Fiscal policy looks set to be stimulatory next year."

This dynamic could be good for Sterling long-term if it generates stronger economic growth.

A surprise was announced at the end of the budget when the Chancellor brought forward planned income tax cuts that take the basic income tax threshold to £12,500 while the upper tax rate is raised to £50,000. They tax relief is brought forward a year and comes into effect in April 2019.

Sterling Tipped to Remain Under Pressure

Most analysts are in agreement that they have not seen anything groundbreaking for the currency near-term, and the Pound will therefore remain keenly focussed on Brexit developments over coming days and weeks.

"It would be silly to make any major changes just a few months before the uncertain end of the Brexit process. Against that background, I believe that a neutral budget is likely," says Marshall Gittler, a foreign exchange strategist with ACLS Global.

"Any major changes are likely to depend on the outcome of the Brexit negotiations – a 'soft' Brexit would probably allow more spending on popular programs, while a 'hard' Brexit is going to require substantial government resources to deal with the fallout. GBP neutral," adds Gittler.

So $GBP barely budged on the Chancellor's early 'banter' ... and policy details lack anything game-changing to distract markets from the obvious short-term no deal #Brexit risks. #Budget2018 snooze fest seeing $GBPUSD now drift back to 1.28 and $EURGBP inching towards 0.89 pic.twitter.com/I5uz7RhG4f

— Viraj Patel (@VPatelFX) October 29, 2018

For the British Pound outlook sentiment remains important and we are concerned that not even good news on the U.K. budget, a hawkish slant at the Bank of England nor good economic data will do much to help the currency.

"GBP retains a weak undertone. UK activity data is holding up relatively well, but Brexit risks are the only focus for markets. So the data can’t add any conviction to market expectations that the BoE may follow up its latest rate increase any time soon. Brexit headlines emerge daily, but short of real progress (or a ‘no deal’), they are unlikely to trigger a decisive directional shift in sterling," says Daniel Been, Head of FX Research with ANZ.

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Lending Data is Mixed

For the British Pound, the day started with the release of money and credit data from the Bank of England, at 09:30 B.S.T., the details of which proved to be mixed.

M4 money supply showed a decline of 0.3%, where markets had forecast the number to have increased 0.3% month-on-month in September. M4 money is the broad level of money flowing in an economy, it is defined as a measure of notes and coins in circulation + bank account deposits and is therefore the blood that pumps through the economy.

An increase in money supply is deemed to be a positive for the outlook of economic activity so this will disappoint U.K. economy watchers.

But, there was some good news on the mortgage front with both lending and numbers of mortgages approved having beaten estimates. 

Mortgage lending grew £3.89BN in September against a forecast for £3BN, mortgage approvals read at 65.27K, ahead of a forecast for growth at 65K.

Lending to individuals was at £4.7BN, ahead of expectations for a reading of £4.1BN.

The outcome of the above has not had large impact on Sterling as we expected; however it does allow us to get an insight into the overall health of the economy and it is therefore a longer-term story in regards to the currency.

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Bank-beating exchange rates: Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here