EUR/GBP has shown a correction with reduced bearish momentum, trading away from 0.860. FX analyst Francesco Pesole suggests markets may already be incorporating some GBP risk premium due to the upcoming UK budget announcement on 26 November, with expectations of budget details being leaked beforehand.
Risks are anticipated to increase for EUR/GBP towards the end of the year. Economists forecast a potential rate cut by the Bank of England this quarter, though only 6 basis points are currently factored into the price. Recent UK economic activity has been low-key, with various speeches but no major shifts expected before the next set of data.
Risk Premium and Market Valuation
A risk premium appears to be building in the Pound ahead of the November 26th UK budget. We see the recent overvaluation in EUR/GBP not as a signal to sell, but as the market starting to price in fiscal uncertainty. Any leaks about the budget in the coming weeks will likely drive Sterling lower against the Euro.
This environment suggests buying EUR/GBP call options with expirations in late November or December could be a sound strategy. This allows traders to position for a potential upward move in the currency pair while capping their maximum loss. Implied volatility may be relatively low now, but we expect it to rise as the budget date approaches and uncertainty increases.
We also see a significant disconnect between market pricing and a potential Bank of England rate cut this quarter. The overnight index swap market is currently only implying a 24% chance of a 25 basis point cut by December, even as slowing retail sales figures suggest the economy is weakening. This divergence presents an opportunity, as any dovish shift from Governor Bailey could quickly reprice the market and weaken the Pound.
Market Caution and Potential Triggers
Memories of the market chaos following the September 2022 fiscal event are likely making traders particularly cautious this time. With the UK’s debt-to-GDP ratio holding stubbornly near 99%, according to the latest ONS data, any suggestion of unfunded commitments could trigger a sharp sell-off in Sterling. We are therefore watching for any pre-budget announcements released to the media in the coming weeks.
