Traders are beginning to ramp up their bearish bets on the British pound ahead of the new government's first budget, which is due in one month.

Industry data shows that options wagering on the pound falling against the US dollar in the week following 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 an even higher share of 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 span the budget announcement, the cost of hedging this event is rising, with implied pound volatility climbing to its highest level since July.

Morgan Stanley Lowers Pound Forecast

FX strategists led by David Adams at Morgan Stanley said: "We believe there is asymmetric risk, and investors may price more negative risk premium into sterling before the October budget." The US bank sharply lowered its pound forecasts, expecting it to fall to 1.30 dollars by year-end and to 1.27 dollars by mid-2027. Sterling is already under pressure from renewed dollar demand driven by the US-Iran conflict and Federal Reserve 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 bets on the pound. But it is worth noting that the market remains significantly divided on the pound's longer-term trajectory. At the end of 2025, Morgan Stanley had predicted sterling 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 a Federal Reserve rate-cutting cycle would erode the dollar's interest rate advantage. Goldman Sachs holds a neutral view, believing 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 public finances. On Monday, UK gilts fell while the pound held around 1.3255 dollars. Roberto Cobo Garcia, head of G-10 FX strategy at BBVA, said a credible budget that preserves fiscal space could help curb volatility in sterling and gilts, but any fiscal consolidation could come at the expense of growth. "We believe there is 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, but others argue that a buffer below 20 billion pounds would pose a problem and the government should stick to the OBR's forecast level. Healey previously said he would meet fiscal rules with a "buffer against uncertainty," but did not specify 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 the "mansion tax" from 2 million pounds to 1.5 million pounds.