Will the UK Budget knock the stuffing out of sterling

As the dollar roars back to life, the pound has come under pressure and is down nearly 2% versus the US dollar in the aftermath of President Trump’s address to Congress. The trade-weighted pound has fared slightly better, but it is still at its lowest level since January.  This supports our theory that since the vote for Brexit last June, the pound’s rallies have been short-lived and fairly shallow, while its declines have been long and merciless.

We believe that Brexit will continue to weigh on the UK currency, especially as we get into the tricky negotiation phase once Article 50 is triggered later this month. However, ahead of this the UK Spring Budget is the next big event risk that could further knock the stuffing out of sterling.

A double-Budget year

The UK Budget takes place on Wednesday 8^th March at 1230 GMT. Although this will be a “full” Budget, it will be the last Spring Budget. Chancellor Phillip Hammond announced back in December that the main Budget would shift to the autumn from 2017, which means that this year we will get two budgets. This doesn’t mean that Wednesday’s Budget is not important, however, it does suggest that the measures announced in this last Spring Budget could be fairly short-term in nature, with the Chancellor giving himself plenty of wiggle room in case Brexit negotiations cause the economy to turn south in the second half of this year.

No Trump-style excess here, please

Hammond’s need for “wiggle room” for later this year means that we don’t expect any big gestures a la President Trump, such as spending programmes and tax cuts. We expect some relief for small and medium-sized businesses, who have had to deal with crippling business rate increases in recent months. If the relief is considered generous and a true counter-balance to the business rate increases then we could see the FTSE 250 extend its recent good run, it hit a fresh record high on Wednesday 2^nd March.

Healthcare boost could be short-lived

We would also expect a cash injection into the NHS, after reports of it struggling under the pressures of the winter months. A large cash injection could provide a temporary boost to the FTSE 100’s healthcare sector, including Astra Zeneca and GlaxoSmithKline; both stock prices have lagged the strong performance of the FTSE 100 in recent months. However, we expect that any boost to the healthcare sector could be temporary, especially if the NHS money is mostly directed to social care, rather than for new drugs etc.

Keeping a war chest at the ready

The Chancellor is likely to provide an upbeat message about the economy, and the public finances; however, he is expected to sound very cautious about the economic outlook for the UK with Brexit waiting in the wings. Although public sector borrowing was at its lowest level for 17 years in January, the Chancellor is likely to reiterate the message that more public sector austerity is to come.  He is also expected to keep a liquid war chest of £27bn, rather than commit to tax cuts or public spending, in case he needs to boost the economy on the back of a Brexit-inspired recession.

Fresh lows for GBP on the cards?

Thus, the chief takeaway from this Budget could be how different our fiscal plans are to those in the US. The US markets and the dollar have rallied strongly on the back of hopes for a tax cut and big spending plan under the Trump administration, the UK government has very different ideas. If this contrast becomes stark on Wednesday, then it may trigger a sell-off in the pound, and 1.20 once again looks possible in GBP/USD. A break below here opens the way to 1.1840 – the low from last year’s flash crash.

Correlation to watch: FTSE 100 and GBP/USD

We think that the impact on stocks will be mild. The FTSE 100 is rising with the tide of enthusiasm from across the Atlantic. Due to the proliferation of multinationals on the FTSE 100, its companies are unlikely to be too effected by any announcements in this Budget. As mentioned above, the FTSE 250 could be in line for a boost, but only if SME’s receive help from the government. Overall, the best outcome for the FTSE 100 would be a decline in sterling, as the FTSE 100 continues to have a negative correlation with GBP/USD.  Since the start of this year, the weekly correlation has been -0.78%, which means that 78% of the time, the FTSE 100 has risen, while GBP/USD has fallen, over the course of a week.

Conclusion:

To conclude, we believe that the biggest impact from this Spring Budget could be the contrasting fiscal stances of the UK and US governments, which may weigh heavily on sterling if the market continues to buy up every dollar in sight ahead of the Fed meeting on 15^th March.  While there are unlikely to be any extravagant moves in this Budget, if the UK can manage its EU exit negotiations and the economy can still defy expectations, then Hammond may be able to pull a few rabbits out of his hat, but traders will have to wait until the autumn.