GBP: Gilt and fiscal story very much in play – ING

The UK fiscal story and what it means for UK asset markets remain very much in play. UK Chancellor Rachel Reeves wants to change the narrative from painful tax rises for businesses to UK growth opportunities. That was the purpose of major policy announcements in Oxford yesterday. Those announcements could also be seen as an effort to sway the thinking of the Office of Budget Responsibility (OBR) as it scores the government's policy agenda ahead of a March review, ING's FX analyst Chris Turner notes.

GBP/USD and EUR/GBP to trade at 1.19/20 and 0.85 respectively

"Recall that the OBR still has relatively high UK growth forecasts up to 2030. And the government will be doing its utmost to persuade the OBR not to revise those forecasts down – which would only make the UK's fiscal position worse. We suspect the government will have to announce some fiscal consolidation in March, largely through real-time spending reductions in the later years of the forecast cycle."

"The relevance of the above is that it is also an effort to restore confidence to the UK gilt market. Another effort in this direction was the Bank of England's announcement on Tuesday of a new contingent facility – the CNRF – to lend cash to Non-Bank Financial Institutions (NBFIs) in the event of dislocation in the gilt market. This will be widely welcomed by the NBFI industry, although it seems less generous than the Fed's Bank Term Funding Progarmme, which lent cash against eligible collateral, without haircut, for a year. The BoE's CNRF tool only gets fired up if the BoE sees a crisis in the gilt market and seemingly only lends funds for one to weeks."

"While these efforts to restore confidence are very welcome – and have helped the sterling trade-weight index recover about 1% from lows earlier this month – we still feel sterling is vulnerable. Fiscal consolidation in March and a drop in services inflation through the second quarter should lead to a 100bp BoE easing cycle this year. This compares to just 68bp of easing priced by the market today. We see no reason to change our end-year GBP/USD and EUR/GBP forecasts of 1.19/20 and 0.85 respectively."