Pound Dips as Traders Eye French Bonds and UK Budget Risks

The British pound weakened slightly against the euro on Tuesday, retreating from a near three-month high reached the day before. The euro had dropped sharply on Monday as fears about French public debt and an upcoming election triggered a sell-off in French bonds, which spread to other markets like Italy. However, French bonds rebounded on Tuesday, pushing yields lower and stabilizing currency markets. The euro rose 0.1% to 84.88 pence after hitting a three-month low of 84.61 pence on Monday following seven consecutive sessions of declines.

Meanwhile, the pound was up 0.1% against the US dollar at $1.322. Traders are closely watching statements from Bank of England officials this week. Catherine Mann, who supported interest rate hikes in July and September, warned on Tuesday that inflation has become deeply embedded in the UK economy. Governor Andrew Bailey and other policymakers are scheduled to speak on Thursday. The central bank has so far avoided raising rates despite the recent spike in energy costs driven by the Iran conflict, but traders are now pricing in an 80% chance of a rate hike in November and around 100 basis points of tightening by the end of next year.

Later this month, the British budget could impact sterling and domestic bond markets. Morgan Stanley advised betting on a decline in the pound, predicting it could drop to $1.285. The bank’s strategists noted that the market may be underestimating fiscal risks ahead of the budget on October 28. They highlighted the challenges of tax hikes and the lack of significant market expectations, suggesting more downside than upside risks for the pound.