Citi Warns Sterling Rally May Fade Ahead of UK Budget Risks

Any near-term strength in the British pound is likely to be short-lived as significant fiscal risks loom ahead of the UK's October budget, according to a new analysis from Citi. The investment bank suggests that while the pound may find temporary support from the Bank of England's upcoming policy decision, investors should use any rally to position for potential downside.

A Hawkish Hold Expected

Attention is focused on the Bank of England's (BoE) policy meeting this Thursday, where Citi Economics anticipates policymakers will hold interest rates steady with a 6-3 vote split. The market has priced in only 5 basis points of rate increases, meaning a "hawkish hold"—where rates are unchanged but the accompanying language signals a readiness to tighten policy—could make UK assets more attractive to foreign investors and provide a marginal lift for the pound.

Citi's currency strategists noted that price action in the EUR/GBP pair appears bearish heading into the meeting, which further suggests potential for sterling gains in the immediate term.

Fiscal Headwinds on the Horizon

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The focus for currency markets is expected to shift from monetary policy to the UK's fiscal situation in the coming weeks. Citi warns that the government's budget, scheduled for October 28, presents a key risk for the pound.

Analysts highlighted that recent weakness in UK government bonds, or gilts, during the budget reference period could constrain the government's fiscal headroom. This, combined with uncertainty surrounding future spending commitments, may lead to increased investor caution next month.

Strategic Outlook for GBP

Given the looming fiscal concerns, Citi said it favors using any pound strength in the coming days and weeks as an opportunity to initiate positions for a potential decline. The bank's view is that as the market's attention pivots from the BoE to the budget, the risks for sterling are skewed to the downside.