The government has refused to rule out tax rises in the budget as it seeks to close the UK’s fiscal gap.
Latest insights:
Tax rises can help to cool inflationary pressures and bring in much-needed revenue but at the risk of reducing economic activity. The impact on money markets can be unpredictable.
As the UK’s Autumn budget draws closer, investors are focused on the possibility of exchange rate volatility after the government refused to rule out tax increases in the 26 November announcement. Income tax, national insurance and value-added tax (VAT) could all be in chancellor Rachel Reeves’ sights as she seeks to bring in much-needed revenue. An income tax hike could be deflationary, lowering household disposable income, though it could also lead to demands for higher wage growth. If Reeves succeeds in cooling inflation, further interest rate cuts could quickly follow, creating exchange rate fluctuations.
The budget promises to be a significant one. Reeves will attempt to pull off the tricky balancing act of lowering household bills without damaging economic growth. Something is likely to give, creating money market movements.
US and China agree trade truce
The other major news this week was the US-China trade truce, negotiated during talks between President Trump and his Chinese counterpart Xi Jinping. The threat of China’s rare earth element export ban was postponed for a year, and the US agreed to lower tariffs on fentanyl-based products.
The news cheered markets and the dollar continued to strengthen against the pound and euro after investors reduced expectations of another Federal Reserve (Fed) rate cut this year. The Fed cut US interest rates by 25bps last week in a widely expected move, but comments by Fed chairman Jerome Powell suggested that any further easing before January was far from guaranteed. The pound hit its weakest level against the greenback since the early spring and the euro was also pressured by the dollar’s rise, weakening to lows last seen in mid summer.
Coming up:
The Bank of England (BoE) is expected to keep interest rates at 4% this week amid concerns about stubbornly high inflation. However, the decision could be tight after recent economic data suggested a slight softening of inflationary pressures. On balance, most economists still think the BoE will err on the side of caution, but a cut can’t be ruled out.
Other key data this week includes the US manufacturing (Monday) and services (Wednesday) PMIs (economic indicators based on a survey of managers), EU retail sales (Thursday) and German balance of trade (Friday).
