Pound Sterling forecast: UK Budget 2021 in focus for traders

• All eyes on Chancellor Rishi Sunak’s UK Budget 2021
• UK Budget poses a potential risk to pound Sterling’s (GBP) recent rally
• UK Services PMI data had little impact on British pound (GBP) exchange rates
• US dollar (USD) outlook remains skewed to the downside

All eyes were turned towards the imminent UK Budget 2021 statement from Chancellor Rishi Sunak at 12:30 GMT, which will prove to be a decisive moment for Britain’s economy and pound Sterling (GBP).

Rishi Sunak is widely expected to increase spending and extend support measures for businesses and individuals until the UK exits lockdown on June 21st.

However, fiscal supported could be overshadowed by tax hikes, which many suggest would act as a headwind to economic recovery and pound Sterling’s (GBP) rally by damaging the UK’s reputation for competitivity and making it a less attractive place to invest.

While the Chancellor could refrain from knee-jerk tax hikes, Mr Sunak previously said that “tough decisions” would need to be made at the UK Budget to bring public finances under control.

That said, the Chancellor has agreed to tie his hands to the Conservative’s “triple tax lock” commitments, which freezes rates on income tax, National Insurance Contributions (NIC) and VAT.

By sticking to the Conservative party’s manifesto commitments, Mr Sunak has few options left to try and bring public finances to sustainable levels, which has led many to believe that businesses will bear the burden of paying for the pandemic.

Although the Chancellor has promised to unleash “fiscal firepower”, substantial increases to Capital Gains Tax (CGT) and Corporation Tax could also be on the cards, which is likely unnerving businesses and investors.

Capital Economics founder, Roger Bootle, said hiking corporation tax could dampen business confidence, which would also hinder economic recovery as a positive business sentiment leads to higher growth prospects.

If the Chancellor’s Budget 2021 is remembered for its tax hikes rather than generous support measures that boost recovery, we expect pound Sterling (GBP) to come under pressure in foreign exchange (FX) markets.

Although GBP is attempting to rebound ahead of the Spring Budget, upside potential will likely depend on whether Mr Sunak’s proposal boosts confidence over the UK’s economic outlook.

Pound Sterling exchange rates rebound ahead of UK Budget

While Chancellor Rishi Sunak’s March Budget could include tax hikes, FX market participants seem confident that the package will focus primarily on spending measures that will facilitate a robust economic rebound, boosting GBP.

Mr Sunak is widely expected to extend the furlough scheme in full until June to continue to support businesses through the third national lockdown. After that, government contributions will be tapered out; he is also likely to extend the business rates holiday by six months and the stamp duty holiday by three months.

MUFG Head of Research EMEA, Derek Halpenny, said: “We suspect the budget to reinforce expectations of stronger growth in the UK relative to the euro-zone.”

The fiscal firepower that the Treasury has promised deploy to protect businesses and jobs should underscore projections for a swift economic rebound in Q2 2021 and allow GBP to remain an outperformer in the G10 universe.

Although Mr Sunak could deliver a statement on raising taxes, most FX market participants don’t expect the Chancellor to use his Budget for a significant tax announcement, which appears to be supporting GBP exchange rates in mid-week trade.

At the time of writing, the British pound to US dollar (GBP/USD) exchange rate is trading 0.2% higher at USD 1.3981. Meanwhile, the British pound to euro (GBP/EUR) exchange rate appears to be eyeing the EUR 1.16 level.

MUFG has also upwardly revised its forecast for the British pound vs euro (GBP/EUR) cross and now see the currency pair hitting EUR 1.1765 by June-end and finishing 2021 above the EUR 1.15 level.

Stephen Gallo, European Head of FX Strategy at BMO Capital Markets, also suggests that the UK Budget is not a huge risk event for GBP. Pound Sterling (GBP) also remains supported by declining COVID-19 cases and deaths as well as the UK’s rapid vaccine rollout.

While all of these factors have been driving upside in GBP for several weeks, the fact they continue to boost optimism over the UK’s economic outlook has prevented sharp losses in GBP/EUR and GBP/USD even when sentiment fades.

The British pound vs US dollar (GBP/USD) pair has also been influenced by UK Services PMI data on Wednesday. The final report from IHS Markit/CIPS for UK service sector activity in February fell short of expectations on Wednesday, rising to 49.5 versus preliminary estimated for a jump to 49.7.

However, the stabilisation of activity in the sector and signs of growth in some technology and business services has allowed GBP/USD to hold firm just below the USD 1.40 level.

US dollar outlook: Will 2021 be a year of decline for the greenback?

The US dollar (USD) has been an outperformer in the G10 space over the past week, recording substantial gains against a host of major currencies. However, most FX market participants remain resolute in their view that the greenback will decline in valued this year.

However, recent price action has challenged this view of long-term weakness as the greenback surged this week and is flat against most of its trading currency rivals..

Bullish momentum in USD exchange rates was triggered by a spike in US Treasury yields last week, which sounded an alarm for risk assets and sent commodity-linked currencies lower in currency markets.

There is also growing expectations that the US Federal Reserve (Fed) will withdraw stimulatory support, which fuelled further upside in US dollar (USD) exchange rates.

However, a currency strategist from RBC Capital Markets suggests that the analyst community’s general view is that this will be a year of declines for the greenback.

The USD 1.9TN US stimulus package and ongoing COVID-19 vaccine rollouts will support the global economy’s recovery outlook and, in turn, drive risk appetite higher.

Although the US currency has gained this week, it remains a massive underperformer against a resurgent pound Sterling (GBP), with GBP/USD up by 2.17% in the year so far.