Berenberg says credible fiscal tightening could calm gilt markets and clear the way for lower interest rates, giving Pound Sterling exchange rates a firmer base.
The Pound Sterling traded mixed on Tuesday, rising 0.1% against the Euro and 0.7% against the New Zealand Dollar while holding near $1.354 against the US Dollar, as markets continued to assess Chancellor John Healey’s fiscal plans following last week’s gilt sell-off.
The Pound-to-Euro rate stood near 1.1664, while GBP/AUD traded around 1.8776 and GBP/CAD near 1.8703.
Berenberg argues that the UK may be the “best of a bad fiscal bunch”, with British borrowing on a more credible downward path than deficits in the United States and France.
“Newish UK Chancellor John Healey’s pledge to meet the fiscal rule set by his predecessor, Rachel Reeves, will limit his room for manoeuvre in his first budget on 28 October,” Berenberg said.
HM Treasury has confirmed that the October 28 Budget will meet the existing fiscal rules, although Healey has yet to explain how the government will finance its promised growth measures.
Higher market rates and bond yields have already made the arithmetic harder.
Berenberg estimates that the change since the Office for Budget Responsibility’s previous projections will add approximately £12 billion to debt-interest spending in 2029-30, consuming just over half the government’s £22 billion fiscal buffer.
The bank expects some tax increases but does not anticipate another major expansion in the size of the state.
Its concern is that poorly designed measures could weaken incentives to employ, work and invest.
“This fiscal consolidation is not only necessary to avoid a nasty reckoning with the bond market, but also the path to faster growth.”
Why Fiscal Consolidation Could Help the Pound
Berenberg estimates that the UK budget deficit narrowed from 5.2% of GDP in 2024-25 to 4.2% in 2025-26 and is on course to reach 3.5% this year.
Even if Healey uses all the available headroom in October, the bank expects the OBR to show the deficit declining to 2.6% of GDP in 2029-30, unless the government also raises planned public investment.
“The bond market would eventually reward the UK for fiscal consolidation,” Berenberg said.
The argument is that tighter fiscal policy would reduce the UK risk premium and give the Bank of England more freedom to lower interest rates without reigniting inflation.
“Tighter fiscal policy and disinflation in the labour market can clear the way for a reduction in interest rates that stimulates private sector activity.”
That offers a more constructive interpretation than the concerns highlighted in our recent report on Sterling’s muted response to Healey’s growth speech.
It also contrasts with Rabobank’s forecast for EUR/GBP to rise towards 0.87, which rests partly on the Pound’s vulnerability to renewed gilt-market stress.
The October Budget will decide which view proves more accurate.
A credible plan could allow lower borrowing costs and stronger private-sector activity to replace fiscal anxiety as Sterling’s domestic story.
Further pressure on the government’s shrinking headroom would risk reviving the negative link between gilt yields and the British Pound.
Our currency coverage draws on live market data, official economic releases and published bank research.
