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Is Parity Calling for GBPUSD after Mini-Budget Volatility?

It’s been a wild old ride for the British Pound over the last fortnight. It has been brought on by a loss of confidence in the new British government and corresponding confidence that the Bank of England can save the day. 

New Prime Minister Liz Truss’s mini-budget administered by Chancellor Kwasi Kwarteng sparked the third largest one-day move in GBP behind the outbreak of COVID and the results of the 2016 Brexit referendum. 

GBPUSD saw a breakdown to fresh, record lows while outsized moves were also seen across the board in GBP pairs. The initial downside move in GBPUSD was then seen continuing on Monday with the pair down by over 10% at the extent of the move. However, in the days following, a sharp reversal matched the decline. GBPUSD rallied off its lows and traded back up to pre-crash levels. 

Given this period of wild volatility, traders are rightfully concerned about what is likely to come next for the UK and how GBP might react. So, with this in mind, let’s take a look at the factors driving GBP price action and how they look set to influence the Pound over the remainder of 2022. 

Factors impacting GBP

  • UK Mini-Budget Impact
  • IMF Criticises UK Government / Fitch downgrade
  • BOE Bond Purchases
  • Government U-Turn on Tax
  • Truss Speech Damages Recovery 

UK Mini-Budget Impact

GBP was sent plummeting lower in response to the fiscal measures announced by the UK government. Among the various features of the budget, the most controversial aspects were plans to cancel a planned rise in corporation tax, abolish the highest tax bracket in the UK and massively increase public borrowing to fund increased expenditure. 

The news was met with a wave of concern and capital outflows as investors feared for the impact on the already fragile UK economy and the repercussion for the BOE. With the UK currently gripped by a seemingly relentless inflationary spiral, the prospect of unfunded tax cuts and a huge increase in public borrowing saw investors driving GBP lower with fears that the BOE would be forced to announce aggressive emergency rate hikes, likely to hurt growth even more in the longer run. 

BOE Bond Purchases

Following the budget and the initial reaction lower, GBP began to quickly reverse as the BOE stepped in and announced an emergency 2-week bond buying package of £65 billion. While the bank refrained from an emergency hike it noted that it would be monitoring the situation and would take action accordingly at the next MPC in November. Under increasing pressure, the government also announced that it would be announcing a full budget, detailing the new measures In their entirety on November 23rd

Government U-Turn on Tax

Along with the BOE’s action, and expectations ahead of the November meeting, GBP was also driven higher by the government’s subsequent response. Following widespread criticism across the political spectrum, including from within the PM’s own party, the government then announced a U-turn on policy. While initially defending the fiscal plan and declaring that it wouldn’t be reversing the tax cuts, the government finally caved in and announced that it would be reinstating the highest tax bracket in the UK and reducing the spending outlined in the budget. 

IMF Criticises UK Government

Of those criticising the government’s budget, arguably the most high-profile was the IMF. The group declared that the UK government’s untargeted tax cuts would simply exacerbate the cost-of-living crisis for UK households. Additionally, the group said that the UK government’s fiscal measures would undermine the BOE’s monetary policy, again sabotaging the UK economy. A second foreign institution joined in on the UK-bashing when Fitch downgraded the UK’s sovereign credit rating from ‘stable’ to ‘negative’.

Truss Speech Damages Recovery 

Having recovered to pre-crash levels, GBP was then seen relinquishing around a third of these gains in reaction to a speech from the new UK PM. Speaking at the Conservative Party conference on Wednesday, Truss warned there are stormy days ahead for the UK economy but vowed to keep an iron grip on the nation’s finances and reaffirmed her focus on growth. GBP plunged subsequently suggesting that either market fears Truss’s efforts will have the opposite effect or instead realise she is highly likely to win a national election and is therefore reflecting growing political uncertainty in the UK. For GBP, the question is, what now? 

Key Aspects to Monitor in GBP

November BOE

Essentially, there are two parts to this. The first is; what will the BOE do on November 3rd? Ahead of recent volatility, expectations were skewed towards further tightening anyway given the still record-high inflation in the UK. While GBP has recovered from the crash, the outlook for the UK economy still remains highly fragile and the BOE is still expected to push ahead with further tightening in November. 

However, expectations are now split over whether the BOE will push ahead with a further 50bps hike, as initially expected, or instead opt for a larger hike. Notably, there was hawkish dissent last time around with 3 members voting for a larger 75bps hike. In light of this, GBP risks into the meeting appear skewed to the upside with more aggressive action likely in the wake of recent market turmoil. 

November UK Budget Announcement 

There has been some confusion, as Chancellor Kwarteng appeared to bring forward the full announcement before reverting back to confirm it would be announced on November 23rd. If the chancellor announces the highest tax bracket will remain and if the proposed spending outlined is reduced in size from the mini-budget, this should keep GBP supported near term, avoiding the harsher, expected economic repercussions. On the other hand, if there are any further surprises, such as the chancellor keeping the initial, proposed spending levels in place, this could renew downward pressure on the GBP. 

GBPUSD Weekly Chart

 

 

The bounce off the 1.0494 level has brought the market back up into the long-term bear channel. While above the bear channel lows, there is room for a further push higher. However, the big level to watch in GBPUSD is the area around 1.2011. This is a major pivot for the market and a break above here, will open the way for a move towards the 1.35 channel highs and the 1.4144 resistance above. Failure at this level, however, will keep the focus on further downside.

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