Spring Budget Offers Pound Sterling a Platform From Which to Advance

Above: The Chancellor of the Exchequer Jeremy Hunt poses outside 11 Downing Street with the Red Box, alongside the other Treasury ministers, before he delivers the Budget to parliament. 10 Downing Street. Picture by Simon Walker / No 10 Downing Street.

The British Pound has further room to advance after the Spring Budget included upgrades to UK economic growth forecasts, inflation forecast downgrades and further efforts to boost UK productivity.

Chancellor Jeremy Hunt stuck to the fiscal rules and resisted testing markets with big pre-election giveaways, which will offer added support to Pound Sterling and UK assets as any lingering risk-premium surrounding the event falls away.

The Pound to Euro exchange rate oscillates near 1.17 after Hunt announced a further 2p reduction to the National Insurance contribution paid by UK workers, aimed at boosting the UK labour market by making work more attractive for the millions of Brits currently opting to stay out of work. The Pound to Dollar exchange rate is up slightly on the day at 1.2718.

"Sterling took today’s UK Spring Budget in its stride, as tends to be the case in all but exceptional circumstances, with Chancellor Hunt delivering no real surprises to markets," says Matthew Ryan, Head of Market Strategy at Ebury.

"It had another big national insurance tax cut, it was broadly fiscally conservative while keeping public spending plans in place, and the independent OBR growth forecasts were upbeat," says Kathleen Brooks, an analyst at XTB.

"Gilt yields are relatively stable, and the pound is back above £1.27 on the back of the stronger OBR UK growth forecasts," she adds. 

Another supply-side reform came as Hunt announced the government would extend the threshold at which parents start paying the High Income Child Benefit Charge from £50,000 to £60,000. The measure is expected to allow parents to take on more work. In fact, Treasury estimates show that today's measures would help 300K people into work.

The Spring Budget sees another freeze in fuel duty and an extension of the temporary 5p tax cut to the duty for another year. Economist Julian Jessop from the IEA says this will knock another 0.2 percentage points off inflation in April - relative to the Bank of England's forecast - while only costing a little over £1BN.

Above: Key forecast changes from the OBR. Track GBP with your own custom rate alerts. Set Up Here

"As tax cut measures were well received, sterling was able to hold on to gains above 1.27, clearly avoiding any 'Truss-style' landmines. Hunt's reference to the OBR expecting inflation to return to 2% within a few months raised an eyebrow, with many still expecting this to take much longer, and FX markets largely ignored any dovish implications of this. GBP/USD continues to edge higher, assisted by constructive technicals, and some recent softer US PMI data," says Joe Tuckey, Head of FX Analysis at Argentex.

According to Hunt, borrowing is now expected to be lower than forecast in the Autumn Statement, prompting a slight fall in UK bond yields as markets interpreted this as meaning there was scope for the Bank of England to cut rates by mid-year.

Hunt announced the government would meet its fiscal rule with £8.9BN of headroom, which is lower than speculated ahead of the announcement, confirming limited freedom to announce decisions that could stimulate the economy and raise inflation.

Above: Real household disposable income per person 

However, the limited fiscal leeway meant the Chancellor was denied the chance to announce bold moves to boost the economy, "This budget meets the Chancellor's 'self-imposed' fiscal rules by £8 billion. NIESR has long argued that the fiscal framework needs an overhaul. By discouraging public investment, the current framework acts as a constraint on growth," says Prof. Stephen Millard, Deputy Director at the National Institute of Economic and Social Research.

Furthermore, the UK tax burden will continue to expand as more workers are pushed into higher-paying income tax brackets as their pay rises.

But upgrades to the economic growth outlook will underpin UK assets and the Pound. The Office for Budget Responsibility (OBR), which sets out the fiscal rules on behalf of the government, says UK GDP will rise 0.8% in 2024 (vs 0.7% expected in the last set of forecasts made in November), 1.9% in 2025 (vs 1.4% in Nov).

Inflation will fall below 2.0% in April as energy bills fall again, but will likely increase again into year-end thanks to above-trend services sector inflation, which is in turn a result of strong wage growth.

Above: UK inflation forecasts are downgraded by the OBR.

The OBR predicts real household disposable income will rise by 0.8% this year, a big upgrade from previous forecasts of a fall.

It estimates the cyclically-adjusted primary deficit will now narrow by 0.9pp of GDP in 2024/25, compared to 1.6pp in the Autumn Statement, making the consolidation in 2024/25 nearly identical to this year's 0.7pp squeeze. As such, fiscal policy is no longer an increasing drag on growth, says Rob Wood, Chief U.K. Economist at Pantheon Macroeconomics.

"We think that today’s measures from Mr Hunt do not change the economic outlook or the MPC's thinking very much. Nonetheless, for rate setters nervous about cutting interest rates, and a market trying to decide whether the first rate cut comes in June, August or September, every little change matters. We still expect the first Bank Rate cut in June, but today’s tax cuts will very marginally add to MPC caution," says Wood.

The Pound has outperformed in 2024 as markets see the Bank of England as cutting rates after the ECB and Federal Reserve; any increased confidence in this expectation can maintain this outperformance status.

"The market cannot assume this is the end of tax cuts because the government may yet squeeze in more changes in another fiscal event ahead of an election later this year," says Wood.