Sterling faces Budget test but medium term outlook is positive

The UK Budget next week will focus investors' attention on the rate of contraction in the UK economy and the government's borrowing requirement over the next few years.

While the figures are unlikely to make pleasant reading, the outlook for sterling will not necessarily be negative and in the medium term is likely to move ahead, according to CaxtonFX, the leading foreign exchange boutique.

Sterling has enjoyed a good run in recent weeks rising to almost $1.50 and €1.13 as stock markets have rallied amid growing confidence that the financial sector might have passed the worst. As a result the appetite for safe havens like the dollar has diminished and there is more demand for riskier currencies like sterling.

"The Budget will put the focus on the serious problems within the UK economy as the fiscal accounts are likely to be very weak and unemployment is rising steeply. But our view is that the UK recession may be bottoming out and the Bank of England has reached the end of the rate cutting cycle," says Alex Dunn, Senior Analyst at CaxtonFX.

"The euro economy is weak and the European Central Bank is likely to cut rates further and move towards quantitative easing. The dollar is likely to weaken as risk appetite returns to the markets. As a result we are now looking for sterling to rise in the medium term even if next week is volatile."