By Alun John
LONDON (Reuters) -Sterling weakened on Thursday after British finance minister Jeremy Hunt announced a budget with a string of tax increases and tighter public spending, saying the economy was already in recession and set to contract next year.
The euro rose 0.4% against the pound to 87.61 pence, while the British currency tumbled more sharply against the dollar, down 1% to $1.179, though this also reflected the dollar's strength against other major currencies.
Outlining a 55-billion-pound plan - almost half from tax rises - to fix the public finances, Hunt said the economy was already in recession and set to shrink in 2023 as it struggles with inflation forecast to average 9.1% this year and 7.4% in 2023.
"Higher taxes and lower spending are necessary evil to get inflation cooling down at this point. The price to pay for this is lower growth, recession and higher unemployment rate. The market reaction has been slightly weaker sterling and gilt markets," said Charles-Henry Monchau, CIO of Bank SYZ, in Geneva.
The pound hit a record low against the dollar of $1.0327 in late September after Hunt's predecessor Kwasi Kwarteng outlined a fiscal plan that added billions to the government's borrowing costs and forced the Bank of England to step in to stabilise the market and protect pension funds.
Sterling has rebounded sharply since then as the dollar weakened across the board on hopes U.S. inflation is slowing and the U.S. Federal Reserve is close to the end of its interest rate hiking programme.
Complicating this narrative however, St. Louis Federal Reserve President James Bullard said on Thursday that interest rates probably still needed to rise by at least another full percentage point.
That sent U.S. treasury yields higher, boosting the dollar, which also rose against the euro and yen
"Don't blame Hunt for lower sterling, it's dollar buying," said Kenneth Broux, senior FX and rates strategist at Societe Generale.
($1 = 0.8372 pounds)
(REporting by Alun John and Amanda Cooper; Additional reporting by Danilo Massoni in Milan; Editing by Raissa Kasolowsky, Jon Boyle and Mark Heinrich)