UK Budget Preview: Showing the way with fiscal stimulus? GBP/USD has room to rally

Cummings' cabinet coup – that now seems like a long-forgotten tidbit of British politics – may have a decisive impact on the pound. 

Earlier this year, Prime Minister Boris Johnson announced a government reshuffle, which put the relatively unknown Rishi Sunak as Chancellor of the Exchequer instead of the more fiscally-prudent Sajid Javid. Johnson and his aide Dominic Cummings wanted to bring the special advisers of the PM and the chancellor under the guidance of 10 Downing Street – unifying the government's message. Moreover, they wanted someone that will follow the vision of infrastructure spending. 

Sunak – which is considered as capable despite accepting having his advisers influenced by Cummings – is now facing his first test with the new budget. Upon assuming his role, he probably could not have imagined that the coronavirus crisis would be the top priority. 

Apart from the response from health authorities, policymakers are trying to mitigate the economic fallout from the fast spread of the disease. Central banks have limited tools as their interest rates had already been low before the crisis. The Bank of England's borrowing costs stand at 0.75% and any rate cut would have a limited effect.

Fiscal stimulus and three scenarios

And that is where the government and Sunak come in – and he seems well-positioned to act. Johnson's government is already leaning toward expenditure on infrastructure and on the National Health Service (NHS), abandoning the austerity policies of previous governments. 

The public is eager for good news amid the health crisis – a sense of confidence and protection – and so are the markets. If policymakers step in to keep the economy running in times of trouble, sterling has room to rise.

Here are three scenarios:

1) End of austerity, but no coronavirus spending: An increase in spending above previous expenditure is priced in and would be insufficient. It would be a mere following of elections results without any special spending to mitigate the fallout from coronavirus. In this scenario, the pound would fall. The probability is low.

2) Special virus outlays: If Sunak presents extraordinary measures to provide relief to the public, that would already be pound positive, but the move in GBP/USD depends on the sums. A token outlay is not the same as splashing billions. The probability of a moderate sum is high. 

3) No limits: The only way to assure a surge in sterling would be not only to announce immediate fiscal stimulus but to make it open-ended. An "everything it takes" commitment from Sunak could send sterling surging. While the language may not be that dramatic, and pledge to add more spending on the go would be welcomed by pound bulls. The probability is medium. 

Conclusion

The UK budget is a significant event in the wake of the coronavirus crisis. Rishi Sunak, the new chancellor, is well-positioned to deliver stimulus. The pound is set to respond positively to additional spending, but a substantial surge depends on an open-ended commitment.