Currency traders bet against sterling ahead of Budget

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Traders are piling into bets that Wednesday’s Budget will push the pound lower against the dollar, on fears that chancellor Rachel Reeves’ tax-raising measures could hurt the UK’s already-weak economic growth.

Trading volumes in put options, used to speculate on or hedge against a fall in the pound, have outstripped those of bullish call options by more than four to one over the past week, according to derivatives firm CME Group. 

That rush of bets on weaker sterling is “pointing to a market that is well positioned for a challenging outcome” for the pound, said Dominic Bunning, head of G10 FX strategy at Nomura.

Weaker than expected economic growth and a fall in inflation in recent weeks have already encouraged traders to intensify their bets on interest rate cuts, which weigh on the attractiveness of a currency.

Many investors think sterling, which is close to its weakest level against the dollar since April at about $1.30, could suffer further at the Budget if Reeves’ tax and spending plans darken the economic outlook — or if they are poorly received by investors already skittish about excessive government borrowing and the Labour leadership’s ability to push through its economic plans.

“It is hard to see how Reeves delivers an outcome which looks bullish [for] UK growth, in a way which would favour the pound,” said Mark Dowding, fixed income chief investment officer at RBC BlueBay Asset Management, adding that the risk of a negative Budget putting pressure on the Labour leadership could also push the pound lower.

Dowding has been betting the pound will weaken against the euro — against which it hit a more than two-year low this month — and the dollar in recent weeks, primarily through currency forwards, another common type of contract.

Some investors are also hoping for measures that will actively push down on inflation, such as reducing value added tax on energy bills. That could weigh on the pound by clearing the way for swifter Bank of England rate cuts.

Sterling puts expiring on Budget day are also significantly more expensive than calls, CME data shows, suggesting that traders think Reeves’ tax plans are more likely to be greeted by sterling weakness than strength.

This so-called skew is at its most pronounced since January, when traders were positioned for a period of sterling weakness around the inauguration of US President Donald Trump. The dollar, which then tumbled over the first half of the year, has stabilised against the pound and other currencies in recent months.

“We are seeing people trade sterling puts more intensively,” said Chris Povey, head of FX options at CME Group.

However, if Reeves is able to create sufficient fiscal headroom for herself, dispel fears of further tax rises next year and deliver better news on growth, sterling could rally, say analysts.

The Budget could serve as a “release valve” for the pound, said Kamal Sharma, director of G10 FX strategy at Bank of America. “[It is] the single most significant binary event of the year for sterling.”

Others warn that concerns over government debt levels could knock sterling, given the doubts over the amount of money Reeves can raise without increasing income tax, as had previously been planned before a U-turn earlier this month.

“If the market does not see enough signs of fiscal consolidation and credibility,” Nomura’s Bunning warned, there is a risk that the pound sells off with long-dated gilts, “a tie-up that has become a bit more frequent in recent years”.

He pointed to weakness in sterling assets in recent weeks on concerns about a potential challenge to Prime Minister Sir Keir Starmer from the left of the ruling Labour party.

“I haven’t heard anyone say good news about sterling or the UK in the last three months,” said Steve Englander, head of FX research at Standard Chartered, pointing to the UK’s “undynamic economy”, high government spending and its limited revenue-raising options given its promises not to raise taxes such as income tax and VAT.