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  •  A Budget not to remember?
  •  Why market reaction could be muted

On Wednesday at 1230GMT Chancellor George Osborne will present his Budget to Parliament. This comes at a difficult time for the Chancellor of the Exchequer, growth faltered in the fourth quarter of last year, and although it is expected to recover later this year it is likely to remain fairly lacklustre into 2013.

However, as much as the Chancellor may want to try and boost growth he needs to balance this with preserving the UK's prized triple A credit rating. Thus, don't expect a deviation from the government's austerity programme, as it has become even more pressing since rating agency Fitch joined Moody's and put the UK on ratings watch negative last week.

But Osborne could have some good news on the UK's deficit. There are signs the UK's finances are better than expected. The Office for Budget Responsibility's borrowing estimate for 2011-2012 was GBP127 billion, however the actual figure is likely to come in below this at the GBP122 billion mark after tax receipts were extremely strong in January and public spending has been slower than anticipated.

The UK still has a mountain to climb when it comes to fiscal consolidation, so don't expect any un-funded giveaways from Osborne this year. Instead we expect a few changes that may cause some volatility in sterling-based markets in the short-term.

The markets are likely to react positively to anything that is pro-business, for obvious reasons. But this budget could be more muted than usual since a corporation tax cut is due to come into effect in April 2012 as part of the Finance Bill. We don't believe the Chancellor will cut the new 25% corporate tax rate any further this year, although a small cut like 1% could surprise the market and might be considered affordable by the Chancellor especially if it could help boost jobs in the UK economy.

Any reduction in red tape for business is also likely to be warmly welcomed by the markets including the outcome of the Office for Tax Simplification's review of the taxation programme for small businesses and a reduction in the compliance burden for firms with foreign subsidiaries.

Added to that any cut to the top 50% rate of tax, which could be reduced to 45% and maybe even back to its original 40%, may not be popular with the overall electorate but could help boost consumption among high earners. The Chancellor may admit that the tax increase for those earning GBP150K or more failed to bring in the GBP 2 billion revenue expected, so is not worth keeping in place.

We believe a pro-business budget may only have a temporary upward impact on the pound. However, a budget that either 1, constrains growth or 2, threatens the UK credit rating could have a longer-term negative impact on sterling. The pound has had a fairly good few sessions as the dollar has been more mixed. It closed the week on Friday above its 200-day sma resistance at 1.5870, however the failure to make progress above here suggests that the bulls may not be in the ascendency and thus we could be back to range-bound conditions for GBPUSD between 1.56 on the downside and 1.59 on the upside.

GBPUSD daily

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Source: Forex.com

As we mentioned above, the Budget tends to have only a temporary impact on markets as most of the detail is signalled by the Chancellor well in advance and so the actual announcement very rarely provides shocks to the market that is enough to drive price action in the medium-term. A much more interesting cross is GBPJPY. This pair broke an important level - the top of the weekly Ichimoku cloud chart, which it hadn't done for four years last Friday. This opens the way to 140.00 in the coming weeks and months.

This cross is unlikely to be driven by domestic concerns in the UK (unless we experience a negative shock in the UK like a credit rating downgrade or a deep double dip recession, neither of which we expect) but this cross is a good way to play yen weakness, in our view.

GBPJPY: Weekly Ichimoku cloud chart

 

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Source: Forex.com

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

d: +44.(0).20.7429.7924 | f: +44.(0).20.7929.2010 | M: +44 (0) 7919.411.957 | e: kbrooks@forex.com| w: www.forex.com/uk

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