Pound vulnerable as traders brace for gloomy budget report

Wed Dec 5, 2012 5:21pm IST

* UK growth forecasts seen lower in UK budget statement

* Autumn statement due after 1230 GMT

* May raise concerns about UK rating downgrade

* PMI data shows UK services sector growth slows

By Philip Baillie

LONDON, Dec 5 (Reuters) - Sterling hovered near a one-month low against the euro on Wednesday and was vulnerable as investors braced for grim tidings from the UK's finance minister in his half-yearly budget statement.

UK finance minister George Osborne will update parliament with new growth and deficit figures just after 1230 GMT. He is likely to paint a darker picture for the economy and commit to more spending cuts in a bid to save his deficit reduction plan.

The euro was down 0.1 percent against the pound at 81.20 pence, having earlier hit a one-month high of 81.45 pence.

Traders said reported euro buying against the pound by a UK clearer had pulled it off its highs, but they expected it to resume its downtrend on the back of downbeat deficit and growth projections from Osborne.

This could potentially see the euro rise towards the late October peak of 81.65 pence.

"Sterling may be a little softer during the speech ... but expectations are well managed for a downbeat statement," one London-based trader said.

Analysts said the prospect of greater fiscal tightening and a weaker economy could raise worries about the prospect of more monetary easing from the Bank of England and about an increased risk of a rating agency cutting the UK's top sovereign rating.

"If they stick to their targets, but delay the timeframe it shouldn't be negative for sterling, but if there are more austerity measures that could be negative for sterling," said Audrey Childe-Freeman, head of foreign exchange strategy at BMO Markets in London.

Some analysts and traders, however, said any negative reaction for sterling may be short-lived, and it may soon return to tracking movements in the euro and the dollar.

"The market is anticipating a difficult Autumn Statement but at the level where sterling is priced at the moment the market understands that and therefore we will not see a reaction," said Steve Barrow, head of G10 currency research at Standard Bank.

He said measures from the statement could bring the UK's prized triple-A rating into question, adding that the Bank of England's 2.0 percent inflation target may become a hindrance.

"If there was some kind of indication Osborne was looking at the remit of the Bank of England that might interest the market."

Against the dollar, the pound was flat at $1.6107, though not far from a one-month peak of $1.6131 hit on Tuesday.

The pound barely reacted to a survey showing Britain's service sector grew at its slowest pace in nearly two years in November. The purchasing managers' index was below forecasts but still just above the 50 level, signalling growth.

TRIPLE-A RATING

Lowered growth forecasts could open the way to more quantitative easing by the Bank of England, which meets on Thursday, BMO's Childe-Freeman said.

QE is generally perceived as negative for a currency. But if the fiscal austerity programme is relaxed too much that could also be negative as it would bring the UK's triple-A rating into question, she added.

But other analysts expect a credible approach to tackling the budget deficit to safeguard the triple-A status.

Citi's economists expect the UK government will be largely able to stick with targets without adding to fiscal austerity measures in the near term.

"We think that the Autumn Statement would reduce the risk of a potential sovereign downgrade of the UK in coming months. In turn, this could reinforce the status of sterling as a safe haven proxy for the euro," Citi told clients in a morning note.

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