Sterling spirals as investors fret over UK budget, gilts sell off
Updates throughout; refreshes prices at 1554 GMT
By Medha Singh and Alun John
Oct 31 (Reuters) -The pound fell on Thursday, set for its worst two-day loss against the euro in two years, a day after new Britishfinance minister Rachel Reeves announced a tax-and-spend budget that investors worried would reignite inflation and weigh on growth.
Sterling was heading for a two-day loss of 0.7% against the euro EURGBP=D3, the largest since September 2022, when then-Prime Minister Liz Truss unleashed turmoil on UK financial markets with budget plans for billions of pounds in unfunded tax cuts.
Reeves' budget on Wednesdaycontained thebiggest tax increases since 1993 as she sought to repair Britain's public services, and she also changed the government's fiscal rules to increase borrowing for long-term investment to boost the economy.
Giving the euro an extra boost against the pound was data on Wednesday that showed a surprise pick-up in the German economy, which has flatlined for months, while the dollar got a lift from yet more evidence on Thursday of the strength of the U.S. economy.
“A lot of news over the last day or two from Europe and the U.S. and so it’s perhaps more difficult to remove just the UK effect from that, so it makes the movements a little more opaque," Rabobank currency strategist Jane Foley said.
"But we can certainly see that this budget has had a large effect," she said.
The Office for Budget Responsibility (OBR), whose forecasts underpin British government budgets, now expects inflation will average 2.6% next year, compared with a previous 1.5% forecast.
A sell-off in UK government bonds accelerated on Thursday, sending two-year gilt yields GB2YT=RR up by over 20 basis points to their highest since May.
Money markets see an 80% chance that the BoE will cut interest rates by 25 basis points at its Nov. 7 meeting, but tradersare now betting on fewer than four rate cuts over the next year from nearly five quarter-point reductions before the budget.
Against the dollar, sterling fell 0.7% on the day to $1.28715 GBP=D3. The euro EURGBP=D3 was up 0.75% against the pound at 84.39 pence.
Reeves said her Labour government had more plans to boost the economy and she hoped to not have to hike taxes again.
"This was a big fiscal event – and the headroom for more is narrow," Bruna Skarica, chief UK economist at Morgan Stanley said.
"In net terms, the event was a bit more BoE-hawkish than we expected, but the scale of the market reaction post the release of the OBR's EFO seems a bit excessive to us."
Graphic: World FX rates in 2023 http://tmsnrt.rs/2egbfVh
Graphic: Trade-weighted sterling since Brexit vote http://tmsnrt.rs/2hwV9Hv
Additional reporting by Amanda Cooper; Editing by Hugh Lawson and Toby Chopra
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