Ahead of the budget, short positions on the pound surged, with Morgan Stanley bearish, targeting 1.30 by year-end.

Ahead of the new UK government's first budget in a month, traders are starting to ramp up their bets against the pound. Industry data shows that options betting on the pound falling against the dollar in the week after the October 28 budget accounted for two-thirds of market volume this month; according to Depository Trust & Clearing Corporation (DTCC) data, bearish options against the euro made up as much as three-quarters. Major banks including Morgan Stanley have also cut their pound forecasts. Investors are worried about the UK's fiscal position and how new Chancellor of the Exchequer John Healey will balance the books. Because one-month contracts cover the budget announcement, the cost of hedging that event is rising, with expected pound volatility climbing to its highest since July. Morgan Stanley cuts pound forecast Morgan Stanley FX strategists led by David Adams said: "We see asymmetric risk that investors may price in more negative risk premium for the pound ahead of the October budget." The US bank sharply lowered its pound forecasts, expecting it to fall to $1.30 by year-end and $1.27 by mid-2027. Sterling is already under pressure from renewed dollar demand driven by the US-Iran conflict and Fed rate hikes, falling more than 2% this month in its worst performance in nearly a year. Risk reversals, a barometer of positioning, also reflect bearish pound bets. But it is worth noting that the market remains significantly divided on the pound's longer-term path. At the end of 2025, Morgan Stanley had predicted the pound could reach a range of 1.43 to 1.51 in 2026, even touching its highest level since the Brexit referendum, with the core logic being that the Fed's rate-cutting cycle would erode the dollar's yield advantage. Goldman Sachs is neutral, arguing that the pound's upward momentum may stall near 1.35 to 1.36, and expects the Bank of England to cut rates three times to 3% in 2026. Wells Fargo is more pessimistic, forecasting the pound will weaken to around 1.31. Current market pricing has clearly tilted toward the pessimistic end, and the divergence itself constitutes an important trading backdrop. UK gilts swing sharply UK bonds have swung sharply this month on fiscal concerns. The Middle East conflict has pushed up UK borrowing costs, and Healey will seek to repair the public finances. On Monday, UK gilts fell while the pound held around $1.3255. Roberto Cobo Garcia, head of G-10 FX strategy at BBVA, said a credible budget that preserves fiscal space could help curb volatility in the pound and gilts, but any fiscal consolidation may come at the expense of growth. "We see limited room for a positive surprise from the budget," Cobo Garcia said. Some gilt investors believe the war-driven surge in yields has made it "unrealistic" for Healey to rebuild buffers to their original level, though others argue a buffer below 20 billion pounds would be problematic and the government should stick to the OBR's forecast level. Healey has previously said he would meet fiscal rules with a "buffer against uncertainty" but has not specified a target size. The government is considering higher taxes on wealth to fund spending, including a bank tax, an increase in capital gains tax, and lowering the threshold for a "mansion tax" from 2 million pounds to 1.5 million pounds.