Shaky UK Growth Weighs on Pound

The Chancellor is under increasing pressure to deliver more in the upcoming budget as the UK's precarious fiscal situation sees rising gilt yields and the pound retreats from a four-year high.

Scrounging for More Cash

The OBR warned on Tuesday that as Chancellor Rachel Reeves seeks ways to increase spending room. With traders keeping a close eye on the health of the UK economy, the GDP release tomorrow, Friday, becomes more critical. An unexpected surge in the British economy could help shore up the government's finances and . Earlier this month, a second round of rumours circulated that the Chancellor may be forced to step down, potentially to be replaced by someone more willing to raise taxes. This move would likely increase concerns among markets and push gilts even higher.

Meanwhile, the , growing by 0.1% in May compared to -0.3% reported in April. Q2 kicked off on a challenging footing, as the first month contracted for the first time in six months, the most significant drop since the end of 2023. Higher energy bills and taxes were seen as the main burdens on the economy, as well as some effects from tariffs. This has given some hope that the downturn is transitory, as PMIs for May and June showed a rebound, and services activity grew to a ten-month high in June. 

Still Facing Obstacles

The core CPI in the UK has remained persistently well above the BOE's target, last reported at 3.5% in May. This has prevented the BOE from offering support to the economy by lowering rates, despite Governor Andrew Bailey saying that the trend for rates is to the downside. However, with traders more concerned about the UK's finances, . Investors worry that investing in the UK comes with increased risk.

Following the UK economy's faltering earlier this year due to increased taxes, traders are likely , with Downing Street refusing to rule out a wealth tax. As Reeves prepares her Autumn budget, she is coming under increased pressure to boost revenue and break her promise not to raise taxes. Her political options are narrowing as she reportedly faces a £20 billion shortfall for next year. Unless the economy recovers, the pound could remain under pressure as investors continue to worry about fiscal policy through the summer.

Pound Readies for Breakout

The cable has been trading within a narrowing range between the Upper and Lower Bollinger Bands at 1.3561 and 1.3621. When the bands squeeze, it often signals an imminent breakout, with the short- to medium-term trend pointing down. On the one hand, a breakdown and eventual loss of 1.3525 would open the door to 1.3500 and 1.3450. On the other hand, reclaiming the top would suggest a local bottom at 1.3565, exposing the regional peak of 1.3645 (which coincides with the ascending autotrend line). This could lead prices to 1.3682 and aim for the 1.3800 handle next.

Source: SpreadEx | GBPUSD

Key Takeaways

The UK continues to face challenges. Sluggish economic growth and rising gilts yields have put pressure on Chancellor Reeves to deliver more in her upcoming budget while concerns about the UK's finances and the possibility of tax increases have weighed on the pound. Despite signs of recovery in recent months, core inflation remains high, which has prevented the BOE from delivering cuts. Investors are keeping a close eye on any fiscal policy measures that could further impact the pound's performance.