Boost to UK Government Finances Ahead of the Budget, Pound Recovers Against Euro

February 22, 2024 - Written by John Cameron

STORY LINK Boost to UK Government Finances Ahead of the Budget, Pound Recovers Against Euro

The Pound to Euro exchange rate (GBP/EUR) dipped to 4-week lows just below 1.1660 on Tuesday before a tentative recovery to 1.1680.

Global central bank interest rate expectations will remain a crucial element for global currency markets with some Euro support as confidence in an April ECB rate cut faded.

GBP/EUR can make headway if there is firm UK PMI business confidence data on Thursday.

According to Jane Foley, senior FX strategist at Rabobank; "It is clear that the process of calibrating the timing and pace of central bank policy moves this year still has some way to go."

As far as the UK is concerned, the fiscal and monetary policy outlooks will both be crucial elements for the Pound.

The UK government recorded a budget surplus of £16.7bn for January, more than double the surplus the previous year of £7.5bn and the largest January surplus on record.

January is always a strong month for tax receipts due to tax payments.

Self-Assessed receipts were slightly lower than the previous year, but this was offset by an increase in income tax, corporate taxes and VAT.

In January, the interest payable on central government debt was £4.4bn, £3.5bn less than in January 2023.

For the first ten months of fiscal 2023/24, the deficit declined to £96.6bn from £99.7bn the previous year, the first time this year that the cumulative deficit dipped below the previous year’s figure.

ONS deputy director for public sector Jessica Barnaby commented; “With recent reductions in the RPI rate, interest payable on government gilts and without last year’s energy support schemes, overall expenditure was down on this time last year, despite increased spending on public services and benefits.”

There will inevitably be a focus on potential tax cuts ahead of the March 6th budget.

KPMG senior economist Michal Stelmach expects the OBR will provide more optimistic forecasts due to lower interest rates and reduced spending on inflation-linked debt.

According to Stelmach; “This could increase the headroom to meet the fiscal mandate to £21 billion, up from £13 billion at the Autumn Statement.

He added; “The policy choice lies between fiscal pragmatism and a stated desire to cut taxes.”

Ruth Gregory, deputy chief UK economist at Capital Economics was less positive; “We think that probable downgrades to the OBR’s GDP and inflation projections will mean the Chancellor has just £15bn (0.5% of GDP) to play with whilst still meeting his fiscal rules.”

She added; “We suspect he will unveil a smaller net giveaway than November’s £21bn of about £10bn (0.4% of GDP) and that he will have to resort to a further squeeze on public spending to meet his fiscal rules.”

She expects tough decisions on spending will have to wait until after the election

The EY ITEM Club considers also points to negative factors due to the technical recession in the second half of 2023. It added; “On balance, the EY ITEM Club thinks the Chancellor will have room to manoeuvre, but major tax cuts are looking less likely.”

Monetary policy will also remain a key element for currency markets.

In testimony on Tuesday, Bank of England Governor Bailey stated that expectations of rate cuts this year were realistic. Although he also insisted that further progress on inflation was needed, he repeated that inflation did not need to fall to 2% before cutting rates.

Commonwealth Bank of Australia strategist Carol Kong commented; "Bailey sounded more dovish than he had been previously and that weighed on sterling a little. We're still comfortable with our forecast for an August start to the Bank of England's easing cycle."

ING notes the significance of fiscal policy; “The prospect of fiscal stimulus may be one of the reasons that sterling is not falling harder after Bank of England Governor Andrew Bailey yesterday said that the BoE does not have to wait for inflation to hit 2% until it cuts rates.”

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TAGS: Pound Euro Forecasts