British Pound reverses earlier gains as UK Public Sector Net Borrowing surges

• GBP/USD retreats below 1.3370 from session highs at 1.3390 and turns negative on the daily chart.
• UK Public sector Net Borrowing increased beyond expectations in August.
• Higher borrowing, coupled with rising bond yields, is leaving the UK government with little fiscal headroom ahead of next month's budget.

The British Pound (GBP) is giving back earlier gains against the US Dollar (USD) on Tuesday as data from the UK revealed that public sector borrowing increased beyond expectations in August, rekindling market concerns about government finances. The GBP/USD pair has retreated to levels below 1.3370, from session highs at the 1.3390 area, although it remains contained within the last few days’ range.

Figures released by the UK National Statistics Office have shown a jump in net borrowing to GBP 18.26 billion in August, from upwardly revised GBP 2.04 billion in July, well above the GBP 15.70 billion forecast by market analysts.

The National Statistics report adds that borrowing rose by about a fifth compared with August last year, more than government income from taxes and other receipts, partly due to the impact of inflation stemming from the Middle East war. Government debt, according to the report, remained below the GBP 3 trillion threshold, although as a share of the economy was lower than a year earlier.

UK fiscal concerns are back on the table

These figures highlight that the UK public sector has borrowed GBP 8.1 billion beyond the Office for Budget Responsibility’s (OBR) forecast in the fiscal year. This poses a significant challenge for Chancellor John Healey, who will have to present a credible fiscal plan at next month's budget, with bond market turmoil leaving him with a very low margin if he does not want to raise taxes.

Looking ahead, ING analyst Francesco Pesole observes that the Pound has been drawing some support from market expectations of some Bank of England (BoE) tightening following last week's meeting, but that it “seems unlikely the BoE will match market expectations." In that case, “some large dovish repricing should still occur at some point," according to Pesole.

The US Dollar, on the other hand, remains buoyed after the hawkish turn performed by the Federal Reserve (Fed) last week. The recent decline in Oil prices has given a fresh boost to risk appetite, but not enough to trigger any relevant USD reversal. Against this background, if US Purchasing Managers data, due later in the week, points to strong economic momentum, hopes of further Fed tightening might trigger a fresh bout of Dollar buying.