UK growth in the third quarter was slightly below expectations, at 0.1% compared to the previous quarter and 1.3% compared to last year. This presents a challenge for Chancellor Rachel Reeves as she prepares the UK Budget. She aims to maintain fiscal responsibility while promoting growth and avoiding increasing inflation.
Political instability in the UK is adding to market uncertainties. Initial concerns about Prime Minister Keir Starmer’s leadership have faded, but increased speculation has caused the EUR/GBP to rise. Currently, the short-term overvaluation risk on this currency pair is about 1.2%.
Cabinet Reshuffle And Rate Cuts
It’s unlikely there will be a major cabinet reshuffle or a change in prime minister before the Budget. The anticipated rate cut from the Bank of England (BoE) in December hasn’t been fully factored into the market yet, so concerns about the strength of EUR/GBP remain limited. After the Budget, the currency pair might stabilize around 0.88, but risks for the pound are expected to continue in the short term.
The recent growth figure of 0.1% highlights the sluggish state of the UK economy. This sentiment is echoed by the October S&P Global/CIPS manufacturing PMI, which dropped to 48.5, indicating a contraction. Such weak economic data increases the likelihood that the Bank of England may cut rates soon. This complicates Chancellor Rachel Reeves’s job, as she must present a UK Budget that reassures markets without hindering growth.
Additionally, the rising political uncertainty regarding the Prime Minister is negatively affecting the currency markets, pushing EUR/GBP to a three-month high of 0.8750 yesterday. This has resulted in a calculated short-term risk premium of 1.2% on the pair, showing that traders want more to hold sterling.
For traders, this environment suggests that protecting against losses on the pound is wise. One-month implied volatility on GBP/USD has risen to 8.5%, leading to costlier options that are, nonetheless, necessary for hedging. We recommend buying GBP puts or using bearish put spreads to manage the risk of further sterling weakness through December.
Upcoming UK Budget And Market Impact
The upcoming UK Budget is a major event that could significantly impact the pound. We recall how the 2022 “mini-budget” shook the markets, and traders should prepare for a possible spike in volatility around the Chancellor’s announcement. Any indicators of spending increases without a clear growth strategy could lead to another sharp sell-off of sterling.
Money markets currently estimate about a 60% chance of a December rate cut from the Bank of England. However, political uncertainties are likely to be the main influence for now. This suggests that EUR/GBP could test the 0.88 level after the Budget, as predicted. Short-term risks for sterling are expected to continue, regardless of what the BoE does next.
Create your live VT Markets account and start trading now.
here to set up a live account on VT Markets now
