The UK's new government budget has become the focus of the market, and after a strong rebound, the pound may face a downward storm.

It is noted that although the pound has largely shaken off the impacts of yet another government change and geopolitical shocks, and has performed better than many of its peers this year, the recent trend of weakening could be exacerbated in the future. So far this year, the pound has gained approximately 1.6% against the euro, 2.8% against the Swiss franc, 4.9% against the Swedish krona, and 1% against the Canadian dollar. During the same period, the pound has remained virtually flat against the dollar, and has decreased by 1.3% against the yen. Prime Minister Keir Starmer resigned on July 20, leaving the UK with its seventh leader in a decade. The market is closely watching whether the new government will adhere to the "fiscal rules" repeatedly emphasized by former Chancellor Rachel Reeves. Under the leadership of Andy Burnham, Starmers quickly appointed successor from the center-left Labour Party, borrowing costs in the UK have risen, but this coincides with a global sell-off in bonds. Matthew Lynn, head of market strategy at financial services firm Ebury, stated that the "smooth and orderly transfer of power" has "eliminated a potential hazard and alleviated the political risk premium evident in the pound." The UK's long-term borrowing costs are at their highest level since 1998. In a report on Friday, Lynn noted that the pound has been an "unexpected outperformer" in the G10 over the past three months, attributing this to the surprising resilience of the UK economy. After a 0.6% growth in the first quarter, the UKs GDP increased by 0.4% in the second quarter, making it one of the strongest-performing regions among developed economies. Clear weather and excitement over the FIFA World Cup boosted consumer spending, and despite geopolitical turmoil, business activity has remarkably remained resilient. Jan Verleij, senior foreign exchange strategist at Rabobank, indicated that during the early period of the conflict in Iran in April, the pound was also supported by excessive market expectations regarding the Bank of England's monetary policy response to inflation concerns. The UK economy is particularly vulnerable to rising oil and gas costs, both of which have surged significantly this year, pushing the overall inflation rate close to 3%. Is the future outlook for the pound worrisome? Despite the resurgence of price pressures, the Bank of England has maintained its benchmark interest rate at 3.75% this year. Current market pricing suggests that the likelihood of a rate hike by the central bank in the September meeting is low. In contrast, expectations are extremely high for the European Central Bank to raise rates on Wednesday, and expectations for the Federal Reserve to hike rates later this month are also growing. Central bank interest rate hikes typically bolster the domestic currency. Verleij from Rabobank pointed out that if the Bank of England signals a dovish stance on September 17, it would make the "pound further exposed to risk," just as the market is preparing for the anxiety leading up to Burnhams governments first annual budget announcement on October 28. The new Chancellor of the Exchequer, John Healey, indicated in a speech on Monday that he will continue to commit to fiscal discipline while striving for more balanced economic growth nationwidecontrasting sharply with the previous situation where growth was highly concentrated in the core city of London. JPMorgan economist Alan Monks stated that given the backdrop of rising borrowing costs, Healey's remarks suggest a cautious stance towards tax and spending changes. In a report on Monday, Monks mentioned that the budget may continue to focus on devolution, enhancing public control in the public services sector, and improving cooperation with the private sector, but is unlikely to change the macroeconomic outlook significantly. Matthew Lynn from Ebury believes the budget carries high political risks and may include operations to "increase auxiliary tax rates to match the increase in debt issuance, in order to fund Burnham's spending ambitions." He noted that these measures could involve adjustments to property purchase taxes and local council taxes, introducing a "mansion tax," and tightening tax reliefs on pensions and personal investment accounts. He further added that the market will feel highly uneasy about any proposals that could stifle economic growth, squeeze the private sector, while also necessitating more borrowing.