Rabobank’s Senior FX Strategist Jane Foley discusses British Pound (GBP) prospects around UK welfare reform, shifting voter polls and the upcoming Bank of England (BoE) decision. Foley highlights how PM Burnham’s fiscal choices and intra-Labour tensions could affect gilts and the Pound. With soft UK inflation but higher Oil prices, Foley expects steady BoE policy and sees EUR/GBP biased higher toward 0.87 over three months.

Politics and BoE expectations drive Pound

“These hints of fiscal restraint have pleased both the gilts market and GBP today. That said, it will be a big test of Burnham’s premiership given that Labour MPs have warned the PM that he would lose their support if he approached welfare reform with ‘punitive cuts’. For now, the markets and the electorate alike appear willing to give Burnham the benefit of the doubt.”

“However, welfare reform is likely to spark friction within the Labour party and could be directional for both gilts and the value of the pound.”

“If Burnham can demonstrate fiscal prudence, the outlook for GBP is set to turn more positive. If he can do this while maintaining coherence within the Labour party, the outlook for the pound will be even better. Realistically, however, there is significant scope for political friction to arise.”

“This would likely be a source of volatility for the pound in the coming months. Indeed, it is possible that Burnham’s honeymoon with voters, Labour MPs and the markets will run out of steam into the autumn, if not before.”

“Given the potential for disappointment over a lack of rate rises from the Bank this year, coupled with the likelihood of political friction over budget cuts, we see risk of an upside bias in EUR/GBP towards 0.87 on a 3-month view.”