The Economist referred to the recent financial plan as a “makeshift budget,” indicating it lacks what Britain truly needs. Similarly, the Financial Times labeled it as a “spend now, pay later” approach, suggesting it merely postpones the inevitable economic strain. The Guardian took a different angle, dubbing it a “live now, pay later” budget, questioning the consequences of this delayed action. As usual, many key announcements were leaked beforehand, which somewhat cushioned the impact and allowed both the pound and long-term government bonds to see some gains. While that’s all well and good, Kit Jux, a currency analyst at Société Générale, pointed out that the budget offers little insight into the country’s economic growth.
Overvaluation of pound increases parity risk
Three main factors will shape the budget’s impact on the pound’s value over the next year. First, there’s the growth forecast, where the UK remains steadfastly un-American in its outlook. The consensus anticipates a 1.1% GDP growth for both the UK and Eurozone by 2026, similar to the expected 1.1% for the United States. This scenario suggests that the EUR/GBP exchange rate will likely stay stable, although both the euro and pound are expected to weaken against the dollar by 2026.
The second key factor is the perspective on monetary policy and interest rates. Economists predict a 50 basis point cut in the Federal Reserve rate next year, while market expectations are looking at a 90 basis point cut. The ECB is anticipated to lower rates by 25 basis points early in the year, potentially reversing this by the end. In the UK, a 1% rate cut is expected by the close of 2026, in line with market predictions. The UK has more latitude to lower rates compared to other nations, which they will likely utilize; however, this won’t necessarily bolster the pound in 2026. Instead, there could be a slight appreciation towards 0.9 in the months ahead, yet it’s clear that both EUR/USD and GBP/USD will decline.
Lastly, the pound is increasingly seen as overvalued in terms of purchasing power parity (PPP). Generally, PPP isn’t a strong indicator (with OECD figures showing 1.50 for EUR/USD, 95 for USD/JPY, and 1.47 for GBP/USD). However, within Europe, where bilateral trade significantly impacts GDP, the fair value of EUR/GBP is gradually rising from a modest 0.90 in 2000. While the pound’s overvaluation is now a concern against the dollar, this situation was more pronounced during the early 2000s and after the euro’s downturn in 2015. Both instances saw the pound fall due to significant events like the Great Financial Crisis and the Brexit vote. Although some correction has occurred since, the UK might face further political challenges ahead.
