Pound softens as French bonds stabilize, focus shifts to UK budget

The British pound softened slightly against the euro on Tuesday, retreating from a nearly three-month high reached in the previous session. The move came as French government bonds rebounded from a sharp decline on Monday, which had fueled concerns about rising public debt and political uncertainty ahead of an upcoming election. Investors had reacted to the earlier selloff in French bonds by pulling back from other eurozone markets, including Italy, but Tuesday's stabilization helped curb further sterling gains.

Sterling had climbed to 84.61 pence per euro on Monday, its lowest point in almost three months, before recovering slightly to 84.88 pence by Tuesday. Against the U.S. dollar, the pound was trading around $1.322, up 0.1%. Market attention now turns to the Bank of England, with policymakers including Catherine Mann and Governor Andrew Bailey scheduled to speak this week. Mann, who has voted for higher interest rates in recent meetings, reiterated on Tuesday that inflation remains deeply embedded in the UK economy.

Traders are currently pricing in an 80% chance of a rate hike in November, with expectations of around 100 basis points of total tightening by the end of next year. The upcoming British budget, set for October 28, is also expected to influence sterling and domestic bond markets. Morgan Stanley warned that the pound may be underpricing fiscal risks ahead of the budget, suggesting a potential decline to $1.285. The bank's strategists cautioned that the budget's tax-hiking arithmetic and unresolved medium-term decisions could introduce significant downside risks.