EUR/GBP has recently corrected, showing less bearish momentum and trading above 0.860. FX analyst Francesco Pesole notes that the markets may already be factoring in some risk for the GBP ahead of the UK budget announcement on 26 November. There are expectations that budget details might be leaked before the official announcement. As we approach the end of the year, risks for EUR/GBP are likely to grow. Some economists predict a rate cut from the Bank of England this quarter, but only a small decrease of 6 basis points is currently reflected in the pricing. The UK’s recent economic activity has been quiet, with various speeches but no major changes expected before the next data release.

Risk Premium and Market Valuation

A risk premium seems to be building in the Pound ahead of the November 26th UK budget. We view the recent overvaluation of EUR/GBP not as a signal to sell, but rather as the market factoring in fiscal uncertainty. If there are leaks regarding the budget in the next few weeks, we expect Sterling to fall against the Euro. Given this situation, purchasing EUR/GBP call options that expire in late November or December may be a smart move. This strategy allows traders to prepare for a possible rise in the currency pair while limiting their maximum loss. Although implied volatility is currently low, we expect it to climb as the budget date nears and uncertainty grows. There’s also a notable gap between market pricing and the potential for a Bank of England rate cut this quarter. Currently, the overnight index swap market shows only a 24% chance of a 25 basis point cut by December, even with recent weak retail sales suggesting the economy is slowing. This discrepancy offers an opportunity since any dovish comments from Governor Bailey could quickly adjust the market and weaken the Pound.

Market Caution and Potential Triggers

Traders are likely feeling cautious, remembering the market turmoil that followed the September 2022 fiscal event. With the UK’s debt-to-GDP ratio staying close to 99%, based on the latest ONS data, any hint of unfunded commitments could lead to a sharp decline in Sterling. We are keeping an eye out for any pre-budget announcements in the coming weeks. Create your live VT Markets account and start trading now.

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