GBP: Austerity times?

In a matter of days, the UK government has shifted from a large and unfunded
expansionary fiscal policy to measures clearly in the direction of fiscal rigour.
Chancellor Jeremy Hunt’s policy U-turn earlier this week has paved the way for a
radically different policy agenda, and many are now speculating on widespread
budget cuts after government offices suggested further savings worth 15% of the
budget may need to be found by the government. A key Conservative policy, the
hike in state pensions in line with inflation, may be scrapped in what could be the
start of a new period of austerity.
Just looking at what the government has already changed from the “mini” Budget,
the implications for markets are very significant. We argued that the U-turn in energy bills cap can add 3pp to inflation next year and should
increase the size/length of the recession. We think the Bank of England will need to
take this into account and will hike by 75bp rather than the 100bp expected by
investors at the November meeting. To be sure, inflation hitting double-digits today

(10.1%), with the core rate at 6.5%, makes any dovish surprise a harder sell.
Today, Prime Minister Liz Truss will face questions by MPs. There is growing
speculation that she will be forced to leave soon due to the loss of credibility and
opinion polls currently suggesting the main opposition party (Labour) holding a 35-
point lead.
GBP/USD has found some tentative stability around 1.13-1.14 as 10-year Gilt yields
edged back below 4.0% for the first time in nearly a month. Our rates team remains
doubtful that sub-4% levels are sustainable and continues to see elevated risks of
Gilt market fragility. A key question is whether the Bank of England will go ahead
with planned Gilt sales from the start of November. Yesterday, a media report
suggesting another delay in quantitative tightening was dismissed as “inaccurate”
by the BoE.
We still struggle to see a return to 1.15+ levels in cable, as a combination of political
instability, risks of a deeper recession and smaller rate hikes by the BoE along the
path of fiscal rigour – along with a strong dollar – may more than offset the benefits
of quieter debt-related concerns. It’s too early to dismiss a return to sub-1.10 levels.

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