Investing.com — Morgan Stanley said sterling prices in too little U.K. fiscal risk ahead of the October 28 Budget and recommended entering a short GBP/USD position at 1.3220.
The bank’s FX strategists set a target of 1.2850 and a stop of 1.3350, saying the trade hedges against “an increase in GBP-negative risk premium.”
“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 consolidation. The strategists estimate the Chancellor’s headroom has narrowed to £8 billion from £24 billion in March, mainly because of higher gilt yields.
To lift headroom back to £15 billion, the bank assumes £15 billion of revenue-raising measures, mostly tax increases. It also assumes a permanent £8 billion rise in day-to-day spending, partly from higher inflation and cost-of-living measures.
As a result, Morgan Stanley sees the headline deficit at 3.7% of GDP next year, 0.7 percentage point higher than in March, with about 0.5 point due to debt-servicing costs. It expects an average £15 billion increase in cash requirements over the next three fiscal years, though only a modest change to in-year needs.
Major medium-term decisions are likely to wait until next year’s Spending Review, when about £11 billion is needed 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.
The bank’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.
Meanwhile, equity strategists 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.
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