TODAY's British budget looks set to underpin the strength of sterling on the foreign exchange markets. The rising British currency yesterday pulled the pound to a new high of 2.5435 against thee deutschmark and most forecasters believe that sterling will get a further boost from today's budget.
The rise of sterling has pulled the Irish currency up in the wake. The pound ended yesterday at the top of the ERM band, standing 6.5 per cent above the weakest currency in the band - the French franc.
The Irish currency has, meanwhile, held above parity with sterling, closing yesterday at 100.09p. However, some analysts' believe that further strength of the British currency could lead to pressure one the pound to fall below 100p sterling.
Today's budget is expected to be a fairly cautious package, involving tax reductions of no more than between £2.25 billion and £3 billion, partly paid for by spending cutbacks. This would underpin confidence in a steady recovery of the British economy next year, which has been one of the factors underpinning sterling. Also, whatever the Chancellor Mr Kenneth Clarke, announces, is unlikely to remove expectations of further increases in British interest rates, which has also been supporting the currency.
The Conservative government trailing badly in opinion polls and facing a general election within six months, has made it clear it sees tax cuts as a key weapon in the fight for votes. But the market had been plagued by a fear that the Chancellor would spring a tax bonanza that British public finances could ill afford.
That concern - one of the few remaining negatives for a British pound boosted by rate hike expectations, healthy economic fundamentals and bullish technical factors - was largely alleviated with new public debt data released last week.
Figures showed a flood of corporate tax receipts helped UK government income outstrip expenditure by a massive £4.4 billion in October, the largest debt repayment in any October since records began in 1968.
Analysts believe that if Mr Clarke errs on the side of caution, sterling will be strongly supported and UK government gilts and the currency should both gain. Even a more generous than expected package could buoy the currency in the short term by increasing the prospect of an early interest rate rise, although it might subsequently lead to concerns about the public finances.
The budget will be a crucial factor in the market's interest rate expectations for the next monetary policy meeting between Mr Clarke and the governor of the Bank of England Mr Eddie George on December 11th.
But, in this critical pre election budget, Mr Clarke must unveil a modest package of tax cuts or risk stoking demand, triggering higher interest rates which could be disastrous to Tory hopes on polling day. However, he is expected to announce a reduction of at least one percentage point in the standard 24 per cent income tax rate, an increase above inflation in personal allowances and cuts in capital gains tax.
