Expectations of tax hikes and interest rate cuts are weighing on the pound, creating the most bearish sentiment since January of this year.

The market is increasingly pessimistic about the outlook for the pound, which has now fallen to its lowest level in months. Traders are worried that the budget bill set to be introduced this month will have little effect on boosting the UK's economic growth prospects. Additionally, the options market shows that pessimism about the pound has reached its highest level since January, when UK government bonds were under pressure due to uncertainties in fiscal and monetary policy. This largely reflects the market's expectations for a possible interest rate cut by the Bank of England on Thursday, which would lower returns for savers and investors and reduce demand for the pound. Currently, the market expects a 33% chance of the Bank of England cutting rates this month, whereas just a few weeks ago this probability was almost zero, with expectations of two rate cuts in the first half of 2026. While budget austerity measures can curb bond speculation, they can also suppress economic growth, potentially leading to more rate cuts. At the same time, UK Chancellor Rishi Sunak has laid the foundation for tax increases in her budget report on November 26, stating that "difficult choices" need to be made to ensure the stability of the UK's finances. Mark Dowding, Chief Investment Officer for Fixed Income at RBC BlueBay Asset Management, said: "We remain bearish on the pound as Sunak seems intent on significant tax hikes, which will damage economic growth." Although the pound has fallen to its lowest level against the US dollar since April, around 1.305, and to its lowest level against the euro since 2023, this has not been enough to encourage investors to buy the pound. Nick Kennedy, FX strategist at Lloyds Bank, said: "Sunak faces a difficult trade-off - fiscal austerity has negative effects on economic growth and confidence, which is currently low." He believes that the euro could rise to a level of 1 euro to 0.9 pounds in the next few weeks. Earlier this year investors were mostly positive on the pound. However, as the outlook for the UK economy and interest rates became uncertain, this confidence has waned, as reflected in the options market. The one-month option risk reversal index for the pound (the difference in cost between holding bullish and bearish options) has fallen to -1.21 percentage points, the lowest level since January, as the cost of holding bearish options relative to bullish options has risen. Derek Halpenny, Head of Global Markets Research for Europe, the Middle East, and Africa at Mitsubishi UFJ Financial Group, said, "Risk reversals have definitely tilted towards the downside," mainly due to changes in expectations for a Bank of England rate cut. This month, the pound has fallen against the Swiss franc, Chinese yuan, and Australian dollar. Although the pound has risen by just over 4% against the US dollar in 2025, this increase is significantly narrower compared to the 9% increase two months ago. Despite the gloomy market sentiment, implied option volatility (a measure of traders' demand for protection against big swings in the pound by the end of November) has remained low. Although this index hit its highest point in two months at 7.2% on Wednesday, it is much lower than the 10% during the January UK government bond sell-off and the 20% during the market crisis caused by the 2022 mini-budget. Halpenny suggested that this may be because UK officials tend to gradually announce budget plans, reducing the element of surprise on the day of the budget announcement, and also implying that investors are cautious about possible early market volatility and unwilling to position themselves in advance. Halpenny added that while traders may be feeling down now, if the budget plans are less austere than expected, the pound may strengthen in the long run. He said: "From the perspective of Bank of England interest rates, I think that an 'aggressive tax increase budget' would have a negative impact on the pound. However, over time, if people believe these tax measures are credible, it will undoubtedly be a stronger factor supporting the pound."