Morgan Stanley recommended a short GBP/USD position at 1.3220 ahead of the October 28 U.K. Budget, targeting 1.2850 with a stop at 1.3350. The bank's strategists say sterling prices in too little fiscal risk as the Chancellor's spending headroom has narrowed since March.
Morgan Stanley told clients to enter a short GBP/USD position at 1.3220, setting a target of 1.2850 and a stop at 1.3350. The bank's FX strategists framed the trade as a hedge against an increase in GBP-negative risk premium heading into the Autumn Budget.
Fiscal headroom has narrowed since March
According to Investing.com: "GBP appears to price too little U.K. fiscal risk ahead of the Autumn budget," the team led by Bruna Skarica wrote. Morgan Stanley expects a low-key Budget that mildly delays fiscal consolidation.
The strategists estimate the Chancellor's headroom has narrowed to £8 billion, down from £24 billion in March, largely because of higher gilt yields. To rebuild headroom to £15 billion, the bank assumes £15 billion of revenue-raising measures, mostly tax increases, alongside a permanent £8 billion rise in day-to-day spending tied partly to inflation and cost-of-living measures.
As a result, Morgan Stanley sees the headline deficit reaching 3.7% of GDP next year, 0.7 percentage point higher than its March forecast, with about 0.5 percentage point of that increase tied to debt-servicing costs. The bank expects an average £15 billion increase in cash requirements over the next three fiscal years, though only a modest change to in-year needs.
Bigger decisions wait for next year
Major medium-term choices will likely wait until next year's Spending Review, when the government needs about £11 billion to lift defense spending to 3% of GDP and another £13.5 billion to prevent real-terms cuts in unprotected departments.
Strategists said risks to the Budget are skewed to the downside, meaning less immediate consolidation or lower headroom. The most plausible upside scenario would be more aggressive action on headline inflation and year-one spending freezes. They noted the U.K. needs foreign capital inflows and that its fiscal plans remain under scrutiny after past upside surprises in borrowing.
Morgan Stanley's rates strategists see mild downside risks for gilts from the delayed consolidation and higher supply, though these may show up more in swap spreads than in outright yields. They expect gross financing needs to rise by about £60 billion next year.
Equity strategists, meanwhile, see limited broad-market risk, saying tax risks look largely priced in for banks. They view the U.K. as a bottom-up, sector-driven market rather than a domestic macro call.
Source: Investing.com
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