By Naomi Tajitsu
LONDON, April 16 (Reuters) - The British government's upcoming budget is likely to reveal dramatically more pessimistic forecasts on the economy and public borrowing this year, putting the brakes on sterling's recent upswing. Chancellor of the Exchequer Alistair Darling on Wednesday is expected to downgrade his economic outlook and concede that the economy is heading for its worst downturn since World War Two.
In addition, the budget may show that state borrowing could reach up to 180 billion pounds during the 2009/2010 fiscal year.
While there's unanimity that Darling's forecasts will paint a much bleaker picture than his last outlook in November, they may still remind traders of the relative fragility of a currency which needs large foreign capital inflows to maintain its value.
For a preview of the budget, click on [ID:nLE117065]
Such a bearish view of the economy could put the brakes on sterling's corrective rally in the past month or so which pushed the currency to a three-month high against the dollar this week. Earlier this year, it had slumped to a 23-year low.
Few analysts expect fireworks from the budget, which rarely sparks a lasting currency reaction. But the immediate risks to sterling appear to be to the downside, with official acknowledgement of the weak economy and public finances enough to sting the currency.
"The budget is likely to show that the economy is going to contract to its worst time in 60 years ... and the next five years or so for the UK look incredibly bleak," said David Page, economist at Investec in London.
Page said that a fall in sterling through $1.45 against the dollar and a rise in the euro beyond 90 pence after the budget's announcement would not be out of the question.
Still, he added that he expected the pound would recover from any initial losses and ultimately hold onto its recent gains to trade above $1.50 by the end of the quarter.
Sterling
STERLING NEGATIVES FACTORED IN
A Reuters poll earlier this month showed a consensus that the UK economy will contract 3.6 percent in 2009. [ID:nL7486644]
This is worse than the International Monetary Fund's prediction for a UK growth contraction of 2.8 percent this year, the deepest recession of all advanced economies.
Given a bigger contraction in growth, many analysts anticipate government borrowing could reach up to 180 billion pounds for the fiscal year -- far exceeding the 118 billion previously forecast by the government in November.
Meanwhile, the deficit may hit around 10 percent of gross domestic product or more, from a previous outlook for 8 percent.
Currency markets will also look to the revised gilt issuance programme from the Debt Management Office, which will be released after the budget.
Some analysts expect issuance will reach a record 180 billion pounds this year, much more than 147.9 billion pounds estimated by the DMO last month.
"If the government is pessimistic on growth, borrowing and long-term debt levels, it could be a potential negative for sterling," said Paul Robinson, chief sterling strategist at Barclays Capital in London.
Still, despite the downward risks that the budget holds for sterling, many in the market expect the currency to build on its recovery seen in past months, given that the market has had ample time to factor in pound-negative issues.
"In the absence of any radically new negative news for the UK ... I can see cable up to $1.60 without any major problems," said Simon Derrick, head of currency research at Bank of New York-Mellon in London.
(Additional reporting by Jamie McGeever, editing by Stephen Nisbet)