Key points
- The UK Chancellor of the Exchequer is expected to “pull a rabbit out of the hat” on measures to curb inflation in Wednesday’s historic budget.
- But a flurry of tax-raising measures will not solve the underlying problems surrounding the UK’s fiscal position.
- Investment strategists told CNBC that the fiscal fallout from the budget could lead to further interest rate cuts.
Strategists have revealed what they expect in UK Finance Minister Rachel Reeves’ Budget, including her “rabbit out of the hat”. For Nuveen’s global investment strategist Laura Cooper, one key thing to watch is the path of UK interest rates. She said that fiscal consolidation in the decisive statement, to be delivered at noon local time on Wednesday, would likely “guarantee even stronger growth pressures in the UK economy,” she said. Speaking to CNBC’s “Europe Early Edition” on Tuesday, Cooper said this would “require the Bank of England to cut rates more aggressively than the markets are pricing in.” The UK’s central bank base rate is currently at 4%, with its Monetary Policy Committee expected to cut the rate by 25 basis points at its next meeting on December 18. But amid reports from the UK’s Office for Budget Responsibility that it will cut the country’s growth projections for 2026 and the next five years, growth rates have slowed. “With markets pricing in around two Bank of England rates by the middle of next year, we think there is scope for an increase of around three cuts by the middle of next year, bringing that terminal rate to 3.25%,” Cooper said. GBP = YTD Mountain Pound Sterling Cooper said growth pressures were likely to mean continued weakness – or at least more range-bound trading – in sterling, which is now at its weakest level against the dollar since April. “It is very difficult to see a catalyst for a renewed rally in sterling,” she added. The British currency acted as a “pressure valve” following initial reports of a possible income tax hike, she said, adding that it had not yet recovered despite Reeves’s pursuit of personal tax hikes. “What we’re seeing is this embedded risk premium in currency,” Cooper said. Against this backdrop, the best risk-reward opportunities in the “belly of the curve” in UK gilts – mostly in the 3-year to 7-year period – were trading “well above” what Cooper said was justified by fundamentals. ‘Rabbit out of the hat’ Sanjay Raja, chief UK economist at Deutsche Bank, predicted that inflation-boosting measures would prove to be the Chancellor’s “rabbit out of the hat”. “We expect 40 basis points of disinflationary measures,” Raja told CNBC’s “Squawk Box Europe” on Tuesday. “That opens the way for rate cuts in December and potentially further into 2026.” The King said the Budget would include “a whole plethora” of measures to increase taxes on pensions, employer wage sacrifice schemes, the gambling industry and landlords’ National Insurance contributions, all of which fall in the chancellor’s crosshairs. “This will be a historic budget,” he added, calling it the UK’s “third biggest tax-raising budget” since the Second World War. With the UK joining the few G7 nations – raising taxes and bringing down deficits – the King said political risk would increase following the Budget and fiscal concerns would persist until 2026. Jim O’Neill, former chairman of Goldman Sachs Asset Management and a member of the UK House of Lords, said Wednesday’s budget added “a couple of surprises”. “Not high expectations.” “They are going to make some effort to ensure that energy and food prices may be under less upward pressure, or in fact may come down a bit, so that they may try to make consumer price inflation weaker than people are currently anticipating, in the belief and hope that that will lead to lower interest rates than the Bank of England,” he said, adding that markets had priced in.