Positive Reaction to Budget Sees Sterling Spreads Rally
This one-off emergency budget is being held against a backdrop of concern about fiscal and sovereign debt woes globally, but especially in Europe.
This presents an opportunity, more than anything else, to show the markets that the new government is credible and, as such, is a credibility test for UK PLC by international investors.
This is therefore an opportunity for the Chancellor to convince the market that the UK is going to adopt a responsible approach to the UK’s finances over the next parliament.
As it is credit ratings agencies will be watching closely with respect to the measures the Chancellor will be taking this afternoon. Standard & Poors has already indicated it would make a decision on the rating in the aftermath of today’s budget, while Fitch has spoken of the enormous challenges facing the government.
The newly set-up Office of Budget Responsibility has already cut growth forecasts for 2011-2014 from Labour’s optimistic targets of between 3.25% and 3.75%, and these forecasts have been cut further in light of the measures announced today.
As expected, spending cuts have led the way with un-ring fenced departments facing cuts of 25% over the next few years. As expected there was also a freezing of public sector pay for those people earning more than 21k a year that was extended for 2 years, while personal allowances were raised to £7,475, from £6,475.
Amongst the tax rises Capital Gains Tax was raised from 18% to 28% for higher rate tax payers. VAT is also to be increased, from January 2011, to 20% which could prove to be inflationary in the early part of next year, but could provide a small sales boost in the lead up to Christmas.
In conjunction with Germany and France there will also be a bank levy introduced based on a banks tier 1 capital ratio from next year and this news initially saw a Sterling drop.
Business corporation tax will also be cut incrementally year by year by 1p in the Pound to 24% by 2014/15, in order to make the UK more business friendly.
Initial market reaction to these budget measures looks positive, with Sterling firmer, and 10 year gilt yields broadly unchanged around 3.46%, remaining near 12 month lows, having fallen quite dramatically in the last 6 weeks.
Against the US Dollar the Pound has held above the support around $1.4680/90, and this area remains the key barrier to further declines towards $1.4500 and the trend line support around $1.4440.
The key to further Sterling gains lies above the trend line resistance around $1.4925, a break of which could well target further gains towards $1.5000.
Euro/Sterling has also gained ground pushing below the £0.8320/30 support area, and while the bigger £0.8400 resistance level holds, further Sterling gains remain likely in the near term.
UK 10 year bond yields have also remained steady, trading off their lows around 3.4080 back to around 3.4800, near to the days highs but still near to 1 year lows.
If the Chancellor was looking to see if his credibility budget was a success, then judging by the market reaction so far it could well be he has succeeded.
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'Positive Reaction to Budget Sees Sterling Spreads Rally', Feature by D. Jones, last update: 22-Jun-10
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