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With sterling trading near a seven-month low against the dollar, markets are bracing for a potentially pivotal UK Budget.
Chancellor Reeves faces a £20-30 billion shortfall in the public finances, and with few easy options, investors are preparing for a new round of austerity which is focused on tax rises rather than spending restraint.
This year’s pre-Budget season has been unusually leaky, with a steady drip of potential measures floated in the media – from manifesto breaking hikes to income tax, to soak-the-rich mansion taxes, to fundamental changes in the country’s energy policy.
Markets suspect this is deliberate expectation management by the Treasury. It is a way to gauge public and political reaction before finalising the package, and to soften the ground for unpopular announcements.
From a market perspective, this approach can cut both ways. On the one hand, it reduces the risk of a nasty surprise that jolts sterling on Budget day. On the other, it risks signalling indecision and political fragility – especially if the final measures appear shaped by short-term pushback rather than a coherent fiscal strategy. Traders will be alert to whether the final Budget feels like a carefully calibrated plan, or a reactive compromise shaped by polling and press headlines.
On the day markets will be focusing on credibility above all.
“For currency traders, the Budget will serve as a real-time credibility test. A rally in sterling is unlikely given the expected fiscal tightening, but if the pound holds its ground, it will signal that investors see the Chancellor’s measures as credible and sufficient to stabilise the public finances without necessarily derailing growth.
Much will depend on whether forthcoming budget measures prove inflationary or disinflationary. Targeted tax cuts, particularly on energy, could ease price pressures, while a repeat of last year’s measures that increased costs for businesses risk reigniting them. The risk is that markets perceive an overreliance on revenue-raising measures that either dampen economic activity, or have the potential to be watered down by Parliament. A repeat of last year’s stop-start fiscal cycle – where U-turns on spending cuts and counterproductive tax rises forced another mid-year adjustment – would damage confidence further and likely push sterling lower.
The upcoming Budget is less about the headline tax measures and more about credibility. If Chancellor Reeves delivers a coherent, balanced plan that stabilises the deficit and anchors expectations, sterling may find a floor. But if the Budget fuels doubts over fiscal discipline or political unity, the pound’s recent slide could deepen before year-end. In short, sterling’s reaction will hinge not on whether taxes rise, but on whether markets believe the Chancellor’s plan restores fiscal credibility without suffocating growth. If Reeves can convince markets that Labour is serious about fiscal repair, sterling could finally find its footing. If not, the slide may just be getting started.
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