GBP/USD faces heightened downside risks as market-implied volatility and risk reversals signal expectations for a weaker Pound Sterling (GBP) ahead of the UK Budget, with a credible fiscal plan from Chancellor Reeves key to restoring investor confidence, Commerzbank’s FX analyst Michael Pfister notes.
Market volatility expected ahead of UK Budget
“Risk reversals clearly showed that most market participants held a similar view, shifting towards more risks for a weaker pound in recent weeks. We are likely to see a further shift towards higher implied volatility and more negative GBP/USD risk reversals in the coming days. Although this shift has already taken place to some extent, last year we only reached the peak shortly after the budget presentation. However, repeated comparisons with the Truss episode, when Liz Truss shocked the financial markets with ill-conceived plans for revenue and spending, are probably inappropriate.”
“Just because the risks from a market perspective clearly point towards a weaker pound does not mean that this will necessarily happen. During both the Truss episode and the last budget, the pound did not perform too badly. This year, however, the situation was different. It seems that officials, with their multitude of ideas, some of which were subsequently cancelled, failed to convince pound investors. We suspect this will continue in the coming days. In other words, the risks to the pound perceived by the market are more likely to materialise this year than last year, given that conditions have deteriorated and the government does not appear to have a convincing plan.”
“In meetings with clients, we are often asked whether most of the negative arguments have now been priced in and what a positive scenario for the pound might look like. Essentially, Reeves would need to present a convincing plan to balance the budget by the 2029–30 fiscal year without reigniting inflation or stifling growth. Possible starting points that could convince the market would include demonstrating fiscal headroom, avoiding tax increases that drive inflation and implementing as few short-term tax changes as possible that merely postpone problems to future years.”
Source: https://www.fxstreet.com/news/gbp-usd-risk-reversals-point-to-weaker-pound-commerzbank-202511260941
