Pound Sterling's Hammond Nudge Higher Tipped to be Temporary

• Pound-to-euro exchange rate: 1 GBP = 1.1176 EUR
• Pound-to-Dollar exchange rate: 1 GBP = 1.3341 USD

Chancellor Philip Hammond's budget helped the British Pound by promising increased spending while proving credible enough to keep his own position secure, but analysts remain cautious on the currency's outlook.

The Chancellor of the Exchequer Philip Hammond was surprisingly generous in his Autumn budget on Wednesday: he slowed down the pace of planned public spending cuts, found a way of cutting taxes and increased spending on housing - all in all, it could not be said that his was an austere budget.

"Net tax giveaways and a significant easing in the pace of spending cuts will provide more support for economic growth," says Lee Hardman, an analyst with MUFG.

The Pound has derived mild support from the event; at the time of publication the Pound-to-Euro exchange rate is at 1.1216 having started the week at 1.1206. The Pound-to-Dollar exchange rate is at 1.3290, having started the week at 1.3212.

Perhaps more importantly, from the currency's perspective, the credibility of the budget could helped buttress support for Theresa May, her Government and for the Chancellor himself who is seen as a credible voice when it comes to Brexit.

The budget was well-received, dispelling fears that Hammond might lose his job after calls for him to quit from baying party extremists, and this also helped Theresa May re-establish control, given Hammond is her right-hand man and 'first mate'.

Indeed, Kathleen Brooks, an analyst with City Index believes the real story for Sterling is the securing of Hammond's position, after all, the Pound does like stability and certainty:

"The reason for this could be relief at his generally good performance and overall weakness in the opposition response from Jeremy Corbyn. As we mentioned ahead of this Budget, the Chancellor’s job was on the line as Brexiteers were circling to get their hands on the Treasury.

"Overall, he did a good job and managed to pull a couple of rabbits out of his hat that increases the image of his competent leadership of the UK Treasury, even with the lower GDP forecasts. This could keep the Brexiteers at bay in the short-term, and Theresa May’s cabinet may stay as it is for another week at least."

Hardman sees these budgetary factors as positive back-draughts for the Pound going forward.

"In light of the challenges the government currently faces, the more stimulative budget appears to have been relatively well received. From that perspective it could help to dampen speculation over whether Philip Hammond will be replaced as Chancellor which posed some downside risk for the pound in the near-term," says the analyst.

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Support for Sterling Tipped to be Temporary?

The Pound has firmed against the Dollar, but against the Euro we have seen some weakness since the budget - largely thanks to an all-round outperformance by the Euro.

The question is how much further can budget-inspired goodwill towards Sterling extend, can it support the Pound into 2018?

A number of analysts we have heard from have suggested that the economic growth forecasts released on budget day point to a tough road ahead for Sterling.

Growth would be less than hoped for and considerably less than other major economies like Germany show economic forecasts from the independent, though Orwellian-sounding, Office of Budgetary Responsibility (OBR).

The OBR downgraded its growth forecasts by an average of half a percent per year for the next 5 years, to an average of only 1.4% per year.

According to Rabobank's Jane Foley, the reason for the lower growth expectations and Sterling's inappropriate decline on the day, is due to a single concept, and that concept is broadely 'productivity' or a lack of.

"The downward revisions to forecasts for UK productivity and growth by the Office of Budgetary Responsibility had been well flagged.  Even so, the revelation in yesterday’s budget that the UK economy is not expected to churn out an annual rate of growth faster than 1.6% between 2017 and 2022 is a depressing outlook," said Foley.

Productivity is the amount of wealth generated by a worker in a given time - such an hour or a day.

It's not the amount the worker earns - rather the total aggregate amount of money made from the worker's work in that time, a certain fraction of which will be paid to the worker as earnings.

An example of a highly productive worker would be a single farmer using a combine harvester to harvest an entire field of wheat in an hour.

An example of low productivity would be forty-nine farm labourers and the farmer all working together for an hour using scythes to harvest the same field.

As can be seen in this example the combine harvester gives one man the leverage of 50, increasing productivity 50-fold.

Currently, the UK suffers from low productivity, and this is one reason, according to Foley, why the OBR slashed growth forecasts.

Yet, the low productivity is there for a reason and that is because of the impact of Brexit, which has lowered the willingness of companies to invest in either the technology or skills to improve productivity.

"In order to make the workforce more productive, higher public and private sector investment is necessary. Currently, the clouds of political uncertainty in the UK are a disincentive for investors,” says Foley.

The UK has also traditionally had a large pool of cheap labour for employers to draw on, negating the need to invest in expensive technological solutions to improve productivity, when increased manpower can do the job for less anyway.

Despite the promise of more spending in the Chancellor's budget Foley sees a lack of productivity hampering visions of real growth, and therefore limiting upside for the Pound.

"The prospect of slack growth in the UK for a prolonged period and the acceptance by the OBR that productivity growth is stuck in slow gear is a negative factor for the pound," she says.

And... it's Back to Brexit

Growth could of course pick up, after all, the OBR's forecasting abilities have long been questioned by economists.

But for growth to pick up, businesses must invest and in order for that to happen they need some clarify on the UK's future relationship with Europe.

Brexit talks are therefore still the ultimate lynchpin for the Pound.

"There is still considerable potential for further Sterling weakness if the negotiations in Brussels are not going well again. At present Brexit talks are going quite well, but there will be problems again at some stage, that is as sure as eggs is eggs," says analyst Ulrich Leuchtman at Commerzbank.

Yet at the same time, the most likely source of growth for the Pound is from improved Brexit talks, if anywhere.

"Between now and the end of the year, Brexit is likely to offer most incentives for GBP.  If the EU summit on December 14-15 does bring an agreement to allow trade talks between the UK and the EU to commence, GBP could be buoyed by relief," says Foley.

But she adds - like Commerzbank's Leuchtmann - that there will be many bumps along the road to a deal, which she thinks a deal will probably only emerge at the "last minute", keeping her sceptical of the Pound.

"Trade talks will be complex and the likelihood that any agreement could be last minute suggests that EUR/GBP still has potentially to move higher in 2018. We maintain a 12 month forecast of EUR/GBP 0.95."

EUR/GBP at 0.95 gives us a Pound-to-Euro exchange rate forecast at 1.05.

This level mirrors the forecast held by analysts at Switzerland's UBS, we offer a full account of their 2018 forecasts here.

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.