Outlook for pound since the UK election

>> Political stability to aid sterling

It is one reason why we are seeing sterling/dollar rising to over 1.40 and the pound pushing on towards 0.80 against the euro.

The incoming Labour government is focused full-time on ensuring financial market stability. It saw the carnage that was caused by the injudicious fiscal easing proposed by former Conservative PM Liz Truss back in 2022. Labor does not want this episode repeated under its watch. But it also wants to grow the economy after years in which it has underperformed both historical norms and the performance of peers.

The difficulty, as we may have found out in yesterday’s fiscal statement by new Chancellor Rachael Reeves, is that these two things might be in conflict. Ensuring financial market calmness leads to a fiscal policy that constrains the room for the economy to flourish. It is not unlike the situation the Conservative’s faced when the Party took over from Labour back in 2010 (in conjunction with the Liberal Democrats).

Back then, incoming Chancellor George Osborne claimed, like Reeves, that the previous government had left an enormous black hole in the budget. Osborne chose to plug this by unleashing a wave of fiscal austerity that most look back on today as a mistake. This was done largely for fiscal stability reasons because the government feared the bond market would be dragged down by the eurozone debt crisis.

However, the UK was never at such risk because the UK authorities had the option of printing money to pay down the debt; an escape route that was not open to Greece and other euro zone countries. Fast-forward to today, and the incoming Labour government is also scared of financial market skittishness. That’s why it pledged before the election to follow two fiscal rules; the first, that borrowing would only take place to cover investment, not consumption, and the second, that the debt/GDP ratio would be on a downward path by the end of the planning period.

And, to add teeth to these fiscal rules, the independent Office for Budget Responsibility (OBR) has been given more powers to adjudicate on the government’s fiscal plans. So far, this has worked to keep the pound and the gilt market stable. On Monday, the chancellor went further when she announced, not just that there is an unfunded GBP22bn shortfall in this year’s budget, but, perhaps surprisingly, that she was announcing measures to try to claw this back.

>> Is it time to buy sterling?

As these efforts include certain investment projects, such as road building, it has led to the inevitable criticism that Labour could repeat the fiscal austerity mistakes of the previous Conservative government, primarily because it fears the financial markets too much. But can any government fear the market too much?

Given the UK’s history of sterling crises in the past, many of which have been policy-induced, it would seem that the answer is ‘no’ you cannot fear the market too much. However, in this case, if the Labour government continues in the same sort of vein and Reeves becomes known as the second austerity chancellor, after Osborne, then there is a danger that it pays too much regard to financial market stability.

Steve Barrow, Head of Standard Bank G10 Strategy does not believe that the UK government will fall into this trap, and subsequent fiscal announcements, starting with the October 30^th budget should demonstrate this. As for sterling, the question is this; is the pound most likely to rise because the government conducts over-zealous budgetary stringency that ultimately costs the economy in terms of its growth potential? Or is the pound more likely to rise because the government has a go-for-growth strategy that, while not taking liberties with fiscal policy, at least allows a notable rise in public investment? “We believe that the latter is more attractive to investors and that the pound will reap the benefits of this approach by rising not just in this ‘honeymoon’ period for the Labour government, but over the longer term as well,” Steve Barrow.