Pound Hits 17-Month High Against the Euro as the Budget Approaches: GBP/EUR update

UK unemployment fell unexpectedly to 4.7% on Tuesday, and pay growth picked up.

On Wednesday, inflation rose to 3.5% in September, above the 3.4% expected and up from 3.1% in August. Fuel did most of the work, with motor fuel prices almost 30% higher than a year ago.

The more important detail for the Bank of England was services inflation, which is driven largely by wages. It rose to 3.7%, above forecasts and well above the Bank's own projection of 3.3%. That raises concern about underlying inflation pressures, although one month's figures do not establish a broader trend.

The pound has now gained close to 2% against the euro in October, putting it on course for its best month since May 2023.

The simplest explanation is the interest rate outlook. Over the past month, markets have added roughly one more quarter-point Bank of England rate rise to their expectations for the year ahead, while taking a quarter-point rise out of their expectations for the ECB, largely because of France.

Markets were already pricing a November rate rise at more than 90% before the inflation figures. Afterwards, that rose to around 95% or more.

Data that reinforces an already widely expected outcome may have less impact on the exchange rate. The pound rose only around 0.2% against the euro on the day.

Markets now expect around four Bank of England rate rises by mid-2027. Many economists think that is too many, pointing to an economy running below full capacity and a Budget likely to tighten spending. If the Bank signals in November that it may not need to go that far, the pound could lose some support even after a rise.

The pound's rise has also been unusually fast, and momentum indicators suggest the rally is stretched.

That does not mean it must fall. But in July, the last time momentum reached similar levels, the pound slipped back by around 1.5% within weeks after the Bank of England held rates. A pause or pullback would not be unusual after a rise this sharp.

The mood is very different from last year. Before the November 2025 Budget, concerns over tax and borrowing plans weighed on the pound, UK government bonds and shares for weeks. This time, sterling is heading into the Budget near its strongest level against the euro in around 17 months.

Government borrowing was £24.5 billion in September, above the £23 billion expected, and national debt passed £3 trillion for the first time. Over the first half of the financial year, borrowing ran around £6 billion above the official forecast.

Debt interest reached £10.9 billion, a record for September. Higher borrowing costs are estimated to have roughly halved the Chancellor's safety margin since March, and most economists expect a cautious Budget with tax rises.

The picture is not all negative. Borrowing over the first six months was more than £4 billion lower than a year earlier, and debt as a share of the economy has fallen over the past year thanks to faster growth. The UK is also one of the few major economies currently reducing its deficit, and many economists expect a low-key Budget with few major surprises.

For the pound, that cuts both ways. A credible plan could reassure investors, and easing Budget concerns have supported sterling in recent days. But tax rises and spending restraint would slow growth, which could reduce expectations for further rate rises.

Borrowing above expectations, or forecasts the market does not believe, could see the pound fall quickly, particularly with the rally already stretched.

France's vote on the tax side of its 2027 budget, due on Tuesday, has been pushed back to 27th October, alongside the vote on its social security budget. Changes already approved by MPs would add around €10 billion to the deficit.

The pressure is building. Protests over the cost of living turned into riots on 17th October, French 10-year borrowing costs reached 5% for the first time since 2002, and the gap over Germany is at its widest in around 15 years.

Yet the euro has held up better than French bonds, helped by a weaker Dollar. Heavy bets against the euro could amplify a recovery if positive news, such as a budget deal, prompts traders to close their positions.

Moody's reviews France's credit rating on Friday evening, with a negative outlook already in place.

Markets expect the ECB to hold its deposit rate at 2.50% on 29th October, with a possible rise in December.

Higher French borrowing costs are already tightening conditions for households and businesses, which may give the ECB reason to sound cautious. A firmer than expected tone would support the euro; a cautious one would add to its weakness.

The pound is supported by expected UK rate rises and France's difficulties, but much of that is already in the price.

It could extend its gains if the Budget reassures investors, the Bank of England signals further rises, or France's problems deepen. It could fall back if the Budget disappoints, the Bank's guidance is softer than markets expect, or France makes progress on its budget.

UK 10-year borrowing costs are now only around 0.4 percentage points above France's, half the gap of a month ago, a sign that investors see France as the bigger concern. With speculative investors still holding large bets against the pound, a Budget that reassures could also prompt a sharp rise as those positions are closed.

For businesses buying euros with pounds, the recent rise is a useful opportunity to review confirmed payments, settlement dates and budget rates ahead of next week's events. Fixing part of a requirement can provide certainty while leaving the remainder open if sterling strengthens further. The fixed portion would not benefit from any subsequent improvement. If you would like to discuss the choices for your upcoming payments, please speak to the Lamera dealing team.

Why is the pound rising against the euro? Stronger UK jobs and inflation figures have reinforced expectations of a Bank of England rate rise in November, while concerns about French public finances continue to weigh on the euro.

Will the Bank of England raise interest rates in November? Markets see a rise on 5th November as very likely. The bigger question for the pound is how many further rises follow.

Is the pound overbought against the euro? Momentum indicators suggest the pound's rally against the euro is stretched. That does not mean it must fall, but sharp rallies often pause or partly reverse.

What does the UK Budget mean for the pound? Investors will judge whether the government's borrowing, tax and spending plans are credible. A reassuring Budget could support the pound; borrowing above expectations could weigh on it.

What could help the euro recover? Progress on France's budget or a firmer ECB could support the euro, particularly with so many traders already positioned against it.