Pound Sterling: Sunak's Spending Pledge "not Significant Enough to Prompt Further GBP Gains" against Euro and Dollar says Strategist

- Pound eyes another weekly advance
- But strength fades in wake of govt. spending announcement
- Govt. targets spending on saving jobs and hard-hit industries
- "more gains in GBP are unlikely" - ING

Above: The Chancellor Rishi Sunak visits a Wagamama restaurant in central London after delivering the Summer Economic Update. Image © HM Treasury, Gov.uk

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The British Pound retains a buoyant tone as markets move through the second half of the week courtesy of a mixture of improvements in sentiment towards EU-UK trade negotiations and the announcement by the Government of a set of new measures designed to underpin the economic recovery.

The Pound is looking to record a second successive weekly advance against the Euro, Dollar and a host of other major currencies but has two hurdles to overcome in order to achieve this feat, the first being the Chancellor's Summer Economic Update and the second being an update on the state of Brexit trade negotiations following this weeks talks.

The Pound shot higher into Tuesday on reports that the EU and UK were close to finding a 'landing zone' for the issue of fishing rights, while the gains were held in the wake of fresh spending announcements from the Treasury.

There was a distinct possibility that were the Chancellor of the Exchequer Rishi Sunak to disappoint markets the Pound would unravel a good portion of the gains it had built up on the Brexit news and the currency's reaction suggests the announcements largely landed on target.

With markets having now digested the Government's new fiscal package, the Pound-to-Euro exchange rate is quoted at 1.1115, having started the week at 1.1087 while the Pound-to-Dollar exchange rate is quoted at 1.2632, having started the week at 1.2483.

"The Pound's reaction to Chancellor Sunak’s fiscal announcement was fairly muted, given that sterling had already front-run the event yesterday (in terms of gains) after policy details started to emerge ahead of the announcement today," says Petr Krpata, Chief EMEA FX and IR Strategist at ING Bank.

"While the size of the stimulus announced is modestly larger than expected, in our view it is not significant enough to prompt further GBP gains. The announced measures today do not significantly alter our UK growth outlook, and with the overriding GBP driver (UK-EU trade negotiations) still looking fairly uncertain, more gains in GBP are unlikely," adds Krpata.

Above: GBP/EUR has recovered ground through July

Sunak opted to present a fresh set of initiatives designed to protect jobs and those sectors particularly hard-hit by the covid-19 lockdowns, namely the hospitality and housing industries.

“The Chancellor is absolutely right to prioritise jobs in his summer statement. Flattening the daunting unemployment curve about to hit our country could not be more important. Joblessness scars lives and hits the young and most disadvantaged hardest," says Carolyn Fairbairn, CBI Director-General. "Prevention is better than cure. Many viable firms are facing maximum jeopardy right now. The job retention bonus will help firms protect jobs."

According to Kallum Pickering, UK Economist at Berenberg Bank the Update provided "measured and targeted" interventions, measured as the Government is clearly not aiming to 'break the bank' with a spending splurge and targeted as there is a clear focus on jobs retention and industries that have been particularly hard hit.

"While the total size of the new measures is more modest than the massive steps taken during the peak of the crisis in March, taken together, they will pack a sizeable punch and support higher private spending with significant implications for hard hit sectors such as construction, housing and hospitality," says Pickering.

The package of initiatives announced includes (with thanks to Berenberg Bank):

• VAT cut: From 15 July 2020 to 12 January 2021 VAT will be cut from 20% to 5% on food and non-alcoholic drinks from food service providers as well as on accommodation and admission to attractions
• Stamp duty cut: From 8 July 2020 to 31 March 2021 stamp duty will be eliminated on properties up to £500K (from £125k)
• Job Retention Bonus: a one-off £1,000 payment to UK employers for each furloughed employee that remains employed through to the end of January 2021
• Kickstart Scheme: funding for 6-month work placements for 16-24 year olds on Universal Credit (covering 100% of the minimum wage for 25 hours per week)
• Eat Out to Help Out: 50% discount of up to £10 per head on meals at participating food services providers (unlimited and valid Monday to Wednesday during August 2020)
• Green Homes Grant: the government will provide at least £2 for every £1 spent on making homes more energy efficient (capped at £5k for most households but up to £10k for low income households)
• Additional funding for the National Careers Service and job centres, increased funding for traineeships and grants of up to £2000 for new apprentices
• Increased spending on infrastructure plus increased spending on public sector and social housing decarbonisation

"HM Treasury estimates the new measures will cost £30bn (Table 1) – equivalent to 1.35% of 2019 GDP. However, as many of the measures are intended to encourage increased private spending through tax and bonus incentives, the economic impact of the package will be materially higher than its estimated costs," says Pickering.

From a foreign exchange markets perspective, the initiatives are ultimately supportive for Sterling should they succeed in minimising the hit to jobs expected when the Government's furlough scheme ends in May.

If it achieves its aim of minimising the negative economic impact of the covid crisis the pressure on the Bank of England to provide further monetary stimulus will fade somewhat.

One significant weight on Sterling's valuation is an expectation that the Bank of England will have to announce further measures to support the economy before year-end, potentially cutting interest rates to 0% or below.

Foreign exchange strategists say a fear of such an unprecedented move is proving to be a substantial source of weakness for the Pound. But should the economy recover in a robust fashion - potentially aided by the spending announcements - the Pound could see this source of weakness fade somewhat.

"If the UK continues to progress with its re-opening without suffering a major renewed spike in infections, then the measures announced can help spur on the recovery. However, if the UK suffers a major second wave that requires national lockdowns or the reclosing of shops, restaurants and the like, the support measures to boost spending on restaurants and entertainment will prove futile," says Pickering.