Sterling slides as tax hikes and growth fears hit UK pound

Sterling suffered a sharp decline against both the euro and dollar on Wednesday as warnings of tax rises and a deteriorating growth outlook weighed heavily on the UK currency. Traders responded to news that Chancellor Rachel Reeves faces a deeper hole in the public finances than forecast, passing the pound down to its lowest level against the euro since April 2023 and marking a fresh low versus the dollar.

The pound touched $1.32 against the US dollar, not seen since early August, and almost dipped to €1.13 against the euro before a slight recovery to €1.14. Markets anticipate a tough budget next month, with the threat of higher taxes and spending cuts. These fiscal challenges have pushed forward forecasts for an interest rate cut from the Bank of England. A quarter-point reduction from the current 4 per cent rate to 3.75 per cent is now expected sooner than previously predicted, with some analysts pointing to the next central bank meeting as a key moment.

Rachel Reeves now contends with a larger-than-expected downgrade to the UK’s productivity outlook. The change has significantly shifted expectations on the timing of monetary policy easing. The shift to earlier rate cuts has put fresh downward pressure on sterling, as investors anticipate looser monetary policy alongside tighter fiscal measures. ING’s Chris Turner noted the market is positioning for fiscal orthodoxy from Reeves, implying tighter budget discipline but requiring monetary support from the Bank of England.

Market analysts suggest this combination—tighter spending, higher taxes, and monetary loosening—tends to weaken a currency, as investors seek out jurisdictions promising higher returns. The British Retail Consortium’s inflation data also showed food prices declining at their sharpest rate since the pandemic, strengthening the case for rate reductions even further. With inflation at 3.8 per cent for the third consecutive month, the Bank of England is under renewed pressure to reduce borrowing costs.

The international backdrop has shifted in parallel. On Wednesday, the Federal Reserve cut US rates by a quarter point, but expectations remain that American interest rates will settle at a higher level than the UK’s. This differential offers added allure to dollar assets. While Reeves’s approach has reduced the UK’s borrowing risk, as reflected in cheaper government financing, the interplay of fiscal discipline and easier monetary policy continues to cast a shadow over sterling’s near-term prospects.