Citi Warns Pound Sterling Rally May Be Short-Lived Amid Budget Risks

The British pound may see a period of temporary strength, but the rally is unlikely to be sustained due to looming fiscal pressures, according to an analysis from Citigroup released Wednesday.

Bank of England Meeting in Focus

Citi's note suggests that price action in the euro-pound cross (EUR/GBP) appears bearish ahead of the Bank of England's (BoE) policy meeting on Thursday, signaling potential for near-term sterling appreciation.

The bank's economics team anticipates the BoE will vote 6-to-3 to keep interest rates on hold. Given that money markets are currently pricing in only 5 basis points of a rate hike, a so-called "hawkish hold" could still support the pound, as relatively higher UK interest rates remain attractive to foreign investors, the note said.

October Budget Poses Downside Risk

Despite the potential for a short-term boost, Citi strategists warned that sterling's strength may prove fleeting. The primary concern is the UK's upcoming budget announcement, scheduled for October 28.

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A recent decline in the value of UK government bonds, or gilts, has likely reduced the government's "fiscal space" during the budget reference period, according to Citi. This could limit the scope for new spending or tax-cut initiatives and raises questions about the UK's fiscal trajectory.

Uncertainty surrounding the government's fiscal commitments is expected to keep investors cautious over the next month as market attention pivots from monetary policy to the nation's finances.

Strategic Outlook

Reflecting these concerns, Citi stated a preference for using any strength in the pound over the coming days and weeks as an opportunity. The bank's strategists suggest this period could be used to position for downside risks before the market's focus fully shifts to the potential negative impacts of the October budget.