Sterling rises against shutdown-focussed dollar; set for fourth monthly loss on euro

The prospect of a U.S. government shutdown is weighing on markets, raising concerns about disruptions to key economic data and Federal Reserve policy decisions. Concurrently, the UK's Q2 current account deficit expanded significantly to £28.939 billion (3.8% of GDP), exceeding forecasts and, coupled with high inflation and borrowing costs, reinforces expectations for substantial tax increases in the November budget, contributing to the pound's sustained weakness against the euro.

Analysis

Markets are navigating dual macroeconomic headwinds from a potential U.S. government shutdown and a deteriorating UK fiscal position. The primary risk from the U.S. political impasse is the potential delay of key economic data, such as the monthly jobs report, which would obscure visibility for the Federal Reserve's monetary policy decisions ahead of its late October meeting. Concurrently, the UK's economic fragility was highlighted by a Q2 current account deficit that widened significantly to £28.939 billion (3.8% of GDP), substantially overshooting the £24.9 billion forecast. This data, combined with the UK having the highest government borrowing costs and inflation rate in the developed world, reinforces expectations for substantial tax hikes in the November 26 budget to address the fiscal gap. These pressures are reflected in the currency markets, where the pound is set for its fourth consecutive monthly loss against the euro, which has gained nearly 4.5% since late May, benefiting as an alternative to both the dollar and sterling amid concerns over UK financial stability.

Key Decisions for Investors

• Given the UK's worsening current account deficit and the pound's sustained weakness against the euro, investors should consider that the path of least resistance for GBP/EUR remains to the downside.
• The looming US government shutdown introduces significant event risk and potential for data blackouts, justifying a cautious or reduced exposure to highly rate-sensitive assets until there is clarity on the Fed's ability to assess the economy.
• Investors should closely monitor UK political discourse leading up to the November budget, as the specifics of the widely expected tax increases will be a critical driver for UK sovereign debt yields and the pound's medium-term trajectory.