Sterling awaits Budget reaction

On Wednesday of next week, Chancellor Alistair Darling is due to give his pre-budget report for the year ahead.

With so much focus on the UK rising debt levels, the markets will listen closely to how the Chancellor plans to curb spending over the next twelve months. Only recently the European Commission published a report stating that the government's plans for reducing the budget deficit are not "ambitious" enough. Whether this has been taken into account in the drafting of the budget remains to be seen though.

The Chancellor has already signalled that he will ignore the advice of the City to spell out where the axe will fall to tackle Britain's soaring deficit. Instead, Labour wants to carry on spending before the election. Whereas the Opposition have shown their intent to implement spending cuts immediately, Mr. Darling has said that he does not wish to imperil the recovery by withdrawing stimulus too soon. In the run-up to the Budget, Mr. Darling has repeatedly defended the government's approach to the deficit arguing that cutting spending too quickly could resurface recessionary pressures.

Duncan Higgins, senior analyst at Caxton FX states, "Thursday's data is certainly encouraging and does point to a slight improvement in the fiscal state of the British economy. However, it must be noted that the excess in the budget could easily be used up this month, with Labour eager to offer something to the electorate ahead of the election."

The City is looking for details of where and when spending cuts will come, but the Budget is likely to be quite light on specifics. So close to the election, the government will be fearful of alienating support by proposing cut backs in vital areas.

Duncan Higgins adds, "We expect the Budget will remain in line with Labour's stubborn course of holding back on cuts until the recovery is stable enough to do so. Although Darling may be able to point to a smaller annual deficit than expected, the situation remains pretty grim and the markets will remain sceptical if detailed polices are not outlined."

"Perhaps of more interest will be the reaction in the polls. With the currency markets so preoccupied with the election, the Budget's effect on the polls will direct sterling's short term movements. Now that Darling has the encouraging public spending figures in his pocket, the Report could be supportive for Labour, narrowing the polls further and sending the pound lower across the board. We expect to see a move back below $1.50 and to hit 1.10 against the euro" concludes Higgins.