The Pound Sterling (GBP) rose this week following relief over the UK Autumn Statement and broad USD weakness, pushing cable above 1.3275 and further away from early November lows. While the UK Budget eased gilt market concerns and raised fiscal headroom, front-loaded spending and back-loaded taxes mean the BoE may still pursue rate cuts amid softer inflation and labor market weakness, MUFG's FX analyst Lee Hardman reports.

UK budget provides fiscal headroom, leaves rate outlook mixed

"The pound has continued to trade at stronger levels at the start of this week after staging a relief rally following last week’s Autumn Statement. The broad-based correction lower for the US dollar helped to lift cable up to a high yesterday at 1.3275 as it moves further above the low from early November at 1.3010. Similarly, EUR/GBP remains below the 0.8800-level after hitting a high of 0.8865 in mid-November."

"There was initial relief that the UK Budget did not contain any nasty surprises to destabilize the gilt market, and that the government took the opportunity to raise fiscal headroom to just above GBP20 billion. However, there are still doubts over the government’s tax and spend strategy given the planned tax hikes are back-loaded to kick in around the timing of the next election while spending is more front-loaded."

"The lack of immediate fiscal tightening does not provide additional impetus for the BoE to cut rates more in the coming years, yet the policy measures will help to lower inflation in the year ahead potentially creating some more leeway to cut rates. We still expect the BoE to resume rate cuts this month encouraged by labour market weakness including slowing wage growth, and recent evidence of softer inflation, which is likely to be sufficient to encourage Governor Bailey to vote for a cut."