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Pound Poised for UK Budget Shakeup

Chancellor of the Exchequer George Osborne poses for photographers outside 11 Downing Street.
Oli Scarff | Getty Images
Chancellor of the Exchequer George Osborne poses for photographers outside 11 Downing Street.

Monetary policy could be set to change in the U.K. when George Osborne, the finance minister unveils his latest budget on Wednesday but any alterations to the Bank of England's remit could sink the sterling even further, analysts told CNBC.

U.K. Chancellor George Osborne is stuck between a rock and a hard place. The more right-wing members of his party are calling for tax cuts while the opposition is urging an increase in spending to boost growth.

Meanwhile economic growth is currently floundering, making it more likely that the U.K. will once again dip into recession after figures last week showed manufacturing output had dropped 1.5 percent month-on-month in January.

(Read More: UK Needs $15 Billion Spending 'Kick Start' in Budget: Economists)

Commentators predict Osborne will neither cut taxes nor increase spending at Wednesday's budget announcement, instead they believe he will pass the buck onto the Bank of England to kick start the economy, by adding a growth mandate on top of the current inflation one.

"One big announcement in the Budget could be a review of the monetary policy framework," HSBC said in a research note. "With the economy flatlining the mood music certainly suggests some sort of change is on the cards."

According to HSBC and Credit Suisse, the BoE could loosen its view on inflation and allow prices to ride higher than its current 2 percent target.

"The U.K. government still finds itself with little room to move on fiscal policy. As such monetary policy remains the principal tool for providing additional support to the economy," Simon Derrick chief currency strategist at BNY Mellon told CNBC.com.

(Read More: UK Must Change Course on Austerity: Opposition Leader)

Any relaxation of the inflation target would allow the Bank of England to fire up the printing presses and add to its 375 billion pound ($566 billion) quantitative easing program. That, in turn, would further weaken the price of sterling.

"I still believe cable (GBP/USD) is a sell from a fundamental point of view," Marshall Gittler, head of global FX strategy at IronFX told CNBC.com. He expects it to break below its current 1.51 level against the dollar to an initial target of 1.4700 and then to 1.4500.

Last week sterling traded below the 1.50 level against the dollar and has lingered around two-and-a-half year lows against the U.S. currency. The pound has fallen over 7 percent against the dollar since the start of the year.

"Are we in the middle of a correction for GBP? Yes. Should the downtrend resume in the near future? Probably," Derrick told CNBC.com.

(Read More: Qatar Lined up for 10 Billion Pound UK Projects Fund)

The pound did get some help on Tuesday, however, with consumer price inflation coming in at 2.8 percent, in line with expectations. On Wednesday, the Bank of England will release minutes from its Monetary Policy Committee meeting, which may give details of any potential asset purchases by the central bank.

Despite the busy schedule the research team at Lloyds bank believes sterling will continue to trade within a tight channel.

"The 1.52 level remains decent resistance on the topside, and the 1.5060 area should be somewhat of an initial support. For EUR/GBP the 0.8530 area should provide initial support, but downside risks come from developments from Cyprus," it said in a note.

Eimear Daly, head of market analysis at Monex Europe believes any prospect of an overhaul of the bank's mandate is already partially priced in to the pound.

"The market is dangerously exposed to disappointment," she told CNBC.com.

"Even if the Chancellor announces a change of remit for the Bank of England, a sterling selloff will be minimal and the currency is likely to regain ground from then on. The devaluation of sterling since January has occurred too fast to be a fundamental correction. The move is partially speculative and open to a sharp reversal."

By CNBC.com's Matt Clinch

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