The GBP has extended its recent rally after yesterday Chancellor of the Exchequer
Jeremy Hunt slashed most of the government expenditures that were part of the
Truss Government’s mini-budget for total savings of c.GBP32bn. While the
government spending bill has been reduced substantially, some additional cuts
may be needed. Indeed, prior to the release, the UK Treasury has estimated that
it would need c.GBP71bn of fiscal tightening to put the UK’s debt-to-GDP on a
downward-sloping path in three years. Given that a big part of the shortfall is due
to funding for the official cost-of-living-crisis measures (that have been further
restricted to cover only the period to April 2023 yesterday), one idea that the Truss
government has been discussing was to use a windfall tax on low-carbon energy
producers. Additional fiscal austerity measures (eg, spending cuts or tax hikes)
may be needed to plug the c.GBP40bn fiscal gap and restore market confidence
in the coming days, however. We think that for the GBP to extend its recent gains,
we need to see further retreat of UK sovereign credit risks. We further continue to
see the risks to the downside for the currency in the coming weeks. This is because
the announced and future fiscal austerity measures will increase the UK recession
risks but dampen some of the inflation pressures given the government’s support
for household energy bills. We therefore think that the BoE will disappoint market
rate hike expectations in the coming months. In addition, the UK external
imbalances are expected to deteriorate further and add to the pressure on
the GBP.