UK pound faces headwinds ahead of November Budget

Investing.com -- The British pound is facing significant challenges as markets focus almost exclusively on the upcoming November Budget, according to Bank of America analysts.

In a report released Monday, BofA noted that despite three significant UK economic data releases last week, markets placed "very little value" in these numbers, suggesting that current macroeconomic data holds minimal information value for investors.

"Markets have placed significant weight to the event risk in late November to the extent that nothing else really matters," BofA stated, pointing to unusual market behavior where sterling fell on wider budget deficit figures rather than rallying on better-than-expected retail sales.

This dynamic has broken the "usual norms" guiding the pound, creating what BofA describes as a "highly asymmetric market" that will likely remain so until investors digest the Budget details. The bank maintains limited appetite for trading UK macro news given developments in the GBP/UK rates correlation.

BofA highlighted concerning developments in recent months, including a negative correlation between sterling and 10-year UK gilt yields, with concurrent selling of gilts and GBP. The pound has declined despite improvements in UK data surprises, further indicating fiscal concerns are dominating sentiment.

The August budget figures showed public sector net borrowing at £18.0 billion, £5.5 billion more than the Office for Budget Responsibility’s forecast and the highest August borrowing in five years. Cumulative borrowing for the fiscal year has reached £83.8 billion through August, £11.4 billion above OBR forecasts.

BofA analysts predict the government’s fiscal headroom could decrease by £20-30 billion in autumn due to the government’s U-turn on spending cuts, potentially higher yields, and growth/productivity downgrades. This would likely transform the current £10 billion headroom into a deficit, necessitating fiscal consolidation measures.

Despite these challenges, BofA expects the pound to recover after the Budget as event risk fades. The bank noted that consensus estimates on UK growth have improved as the service sector/manufacturing mix allows the economy to better weather tariff-related disruptions.

For traders, BofA suggests current levels in EUR/GBP look attractive from both spot and skew perspectives, particularly in longer-dated options. However, they do not expect a sustained rally in the pound before the Budget, suggesting selling GBP on rallies.