Morgan Stanley Bets Against Pound Before UK Budget Announcement

Morgan Stanley has taken a bearish stance on the British pound ahead of the U.K. government's upcoming budget announcement on October 28. The bank's foreign exchange strategists recommend entering a short position at 1.3220, with a target of 1.2850 and a stop at 1.3350. They argue that the pound currently underestimates the fiscal risks associated with the budget, which could lead to a higher risk premium for the currency.

The strategists led by Bruna Skarica expect a relatively low-key budget that will slightly delay fiscal consolidation. They note that the Chancellor's headroom has narrowed significantly from £24 billion in March to just £8 billion, primarily due to rising gilt yields. To restore headroom to £15 billion, Morgan Stanley anticipates £15 billion in revenue-raising measures, mostly through tax increases, and a permanent £8 billion increase in day-to-day spending.

As a result, Morgan Stanley forecasts the headline deficit to reach 3.7% of GDP next year, up from 0.7 percentage points compared to March. The bank also expects an average £15 billion increase in cash requirements over the next three fiscal years. Major spending decisions are likely to be deferred until next year's Spending Review, which will address defense spending and prevent real-terms cuts in unprotected departments.

Risks to the budget are seen as skewed to the downside, with the most plausible upside scenario involving more aggressive action on headline inflation and spending freezes. The bank's rates strategists see mild downside risks for gilts due to delayed consolidation and higher supply, while equity strategists view the U.K. market as sector-driven rather than dependent on domestic macro factors.