British Pound: Fiscal policy uncertainty and Sterling reaction – MUFG

Lee Hardman at MUFG highlights that the Pound has modestly recovered after losses following Andy Burnham’s appointment as UK Prime Minister, while long-dated gilts remain under pressure. Market focus is on Burnham’s use of flexibility within existing fiscal rules, planned VAT cuts on electricity bills, and the appointment of John Healey as Chancellor, which together increase uncertainty over the UK’s fiscal trajectory.

Pound tracks evolving UK fiscal stance

"The pound has strengthened modestly overnight retracing some of the losses sustained yesterday after Andy Burnham was formally appointed as the new Prime Minister. There has been a bigger and more sustained sell-off in the gilt market where the 30-year yield remains around 7bps higher. The pound and gilt market sell-off yesterday was triggered by comments from Andy Burnham stating that “we’ll stick to the existing fiscal rules and use obviously any flexibility with them”."

"One of the first policy changes to be announced will help to reduce the cost of living. He has announced a GBP850 million plan to cut domestic energy bills by removing VAT on household electricity bills. The reduction in VAT on electricity bills from 5% to 0% is expected to lower inflation by 0.1ppt according to the government."

"Prime Minster Burnham has emphasized that any measures to cut the cost of living would be fully funded, and further policy measures are under consideration. The VAT cut on electricity bills will be funded by axing the digital ID scheme. Adding to uncertainty over the fiscal policy was the surprise announcement that former Defence Minister John Healey has been chosen as the new Chancellor."

"It has fuelled speculation that defence spending will be increased more going forward given he resigned from Keir Starmer’s government citing concern over inadequate defence spending plans. He wanted the government to commit to raising defence spending more quickly to 3% of GDP by 2030. He is viewed as being on the moderate or centre-left wing of the Labour party helping to ease concerns over the risk of a much looser fiscal policy."