“A billion here, a billion there—sooner or later it adds up to real money.” Senator Everett Dirksen

British finance minister George Osborne released the details of the highly anticipated course of £6.2 billion worth of budget cuts this morning. Osborne has said that  “This is the first time this government has announced difficult decisions on spending,” said Mr Osborne. “It will not be the last. But we do not do this for the sake of it but to improve people’s lives and improve Britain’s economic future.” The cuts on public spending will be mainly affecting the departments of; business, transport, work and pensions, education and communities and local government. The government insist that the first round of cuts will not affect schools or hospitals or defence but the future is looking bleak with the £6.2 billion being minuscule compared to the 2011 monstrosity of £40-50 billion. The embarkation on ‘the age of austerity’ as Mr Laws likes to claim, is causing some ripples in the pond, with trade union members grabbing their metaphorical burning torches and pitchforks and heading towards parliament. The Public and Commercial services union warned that these cuts would seriously damage the civil service and push it to ‘breaking point’.

It is important to remember that the although the country seems to be expecting these cuts to have a ‘double dip’ affect on the recession, that this is most likely not the case. The cuts will obviously rain on economic growth’s parade but the real worries will come next year. Whatever the outcome, these cuts are being put in place to attempt to reduce our crippling deficit, and for that reason the attempts to root out the unnecessary public spending are for a good cause, and yes – the numbers do add up, for now.

Public finances seem to be improving, with data out on Friday giving the budget cuts a bit of a leg up. However, public net borrowing hit £10bn in April which was a record but underlying trends seem to say borrowing is coming off from the highs of the past year or so. It is clear that the government have a great deal of work to do in order to reduce the deficit, and even if things are improving from detrimental to awful we are by no means out of the wood.

Cameron defied the ash cloud last week, making his first visits overseas to meet Sarkozy and other EU partners, with the French president noting the visit as ‘symbolic’, Cameron is very keen to create a closer relationship with France commenting  that it was ‘in Britain’s interest that the Euro is a success’. He also visited Merkel on Friday, and this clear link from France to Berlin should highlight the new prime ministers desire to help calm the frosty EU atmosphere.

Concerns over the UK’s house prices have resurfaced as mortgages approvals for April are at the lowest they have been for a year, which has caused the recent house price high seem precarious. More details have emerged from the BOE have shown that only about 1.5 million households with a mortgage have enough cash in their property to reduce their outgoings by refinancing This news has produced the belief that house prices will be volatile and jumpy over the next few months.

Overall, sterling struggled to take off last week and it looks like this week could be similar, with GDP and Consumer Confidence out and more repercussions from the budget cuts making the week an interesting one.

With the rates staying in the same range as they were last week our trade recommendation remains the same and we advise buying a ‘Leveraged Reduced Premium Risk Reversal’ for those of you looking to hedge an exposure going forward in GBPEUR. This structure is completely free to the client whereas normal risk reversal structures may normally cost up to 3% of the notional amount. 

The structure allows a worst case rate (WCR) of 1.1350 and a top level barrier of 1.21. To benefit from the increased volatility we have added a disadvantage from 1.07. So for every percentage point the rate on expiry is below 1.07, the client loses the same off their WCR. While this is a disadvantage we think this risk is worth taking as we do not expect massive sterling weakness against the euro anytime soon and allows you to increase the headroom on the upside.

If it continues to rise, as we and the market expect, then the client is able to benefit all the way up to 1.21. This level is not a barrier and instead acts as a cap, a prospect a lot of hedgers prefer. This is simply the best structure we have seen for clients in GBPEUR since the beginning of the credit crunch as it allows 100% upside with no knock-in for no upfront premium and with a tight WCR to current market, normally unheard of in markets such as these

For further details and for live pricing speak to one of the options trading team on 0207 801 9050.

Please feel free to contact me, Georgia Raimes, (research@worldfirst.com) if you have any questions or thoughts regarding these updates or if you are interested in a particular event in the calendar. If you would like to discuss your foreign exchange requirements, please contact our: Corporate Foreign Exchange Team on 020 7801 9050 or our Private Client Currency Exchange Team on 020 7801 9080.