UK growth for the third quarter was slightly lower than expected, at 0.1% quarter-on-quarter and 1.3% year-on-year. This presents a challenge for Chancellor Rachel Reeves as she prepares the UK Budget, aiming to balance fiscal prudence with growth, without exacerbating inflation.
Current political turbulence in the UK is adding to market uncertainties. While initial concerns about Prime Minister Keir Starmer’s leadership were dismissed, increased speculation has impacted the EUR/GBP, which is now trading higher. The short-term overvaluation risk premium on the pair is estimated at 1.2%.
Cabinet Reshuffle And Rate Cuts
A major cabinet reshuffle or a change of prime minister before the Budget is considered improbable. With the December BoE rate cut not fully factored in yet, there is limited concern about EUR/GBP strength. Post-Budget, the pair may stabilise around 0.88, but risks for sterling are expected to persist in the short term.
The recent third-quarter growth figure of 0.1% confirms the sluggish state of the UK economy, a view supported by the latest October S&P Global/CIPS manufacturing PMI which fell to 48.5, indicating a contraction. This soft data landscape increases the likelihood of a Bank of England rate cut in the near future. This complicates the job for Chancellor Rachel Reeves, who must present a UK Budget that reassures markets without stifling growth.
Compounding this economic weakness is the rising political uncertainty surrounding the Prime Minister. We have seen this political anxiety translate directly into currency markets, pushing EUR/GBP to a three-month high of 0.8750 yesterday. This has created what we calculate as a 1.2% short-term risk premium on the pair, showing traders are demanding more to hold sterling.
For traders, this environment suggests downside protection on the pound is prudent. One-month implied volatility on GBP/USD has ticked up to 8.5%, making options more expensive but also more necessary for hedging. We believe buying GBP puts or implementing bearish put spreads offers a defined-risk way to position for further sterling weakness into December.
Upcoming UK Budget And Market Impact
The upcoming UK Budget is now the key event risk on the horizon, creating a potential binary outcome for the pound. We all remember how the 2022 “mini-budget” roiled markets, and traders should be prepared for a similar, if less dramatic, spike in volatility around the Chancellor’s announcement. Any signs of fiscal loosening without a clear growth plan could trigger another sharp sterling sell-off.
While money markets are only pricing in about a 60% chance of a December rate cut from the Bank of England, the political overhang could be the dominant driver for now. This suggests EUR/GBP could test the 0.88 level post-Budget, as forecasted. Short-term downside risks for sterling will likely persist regardless of the BoE’s immediate actions.
