Sterling was up against the USD by 0.08% to $1.27, while the pound also edged higher against the euro, up by 0.18% to €1.17.
The budget deficit between April and July 2023 was £56.6bn, according to the Office for National Statistics (ONS).
The borrowing figure was some £11.3bn less than the Office for Budget Responsibility (OBR) had forecast it to be in March.
However, whilst it was below the OBR forecast, it was still £3bn more than last year’s figure for the same month.
“The pound has been a touch stronger against the euro so far today, extending its rally to more than 1.5% since mid-August, and trading around its highest level in five weeks. News of July’s smaller-than-expected budget deficit may partly be buoying GBP, as this could provide more wiggle room for the UK government to cut taxes, and therefore support growth, ahead of the next general election,” said Matthew Ryan, head of market strategy at financial services firm Ebury.
“That said, ongoing concerns surrounding the state of the Chinese economy continue to largely dominate the narrative in markets. Unlike the euro area, Britain is not overly dependent on demand from Asia’s largest economy, so recent soft China data, and worries over the health of the country’s property sector, appear to be providing the GBP/EUR pair with a further leg up,” he added.
Giles Coghlan, chief market analyst, consulting for HYCM, said: "With borrowing figures rising less than anticipated, the GBP’s show of strength against both the Euro and the Dollar is a sign that inflation is easing, slowly but surely.
“However, interest rates continue to rise and expectations of a mild recession remain – investors should note that inflation figures are expected to rise again when August’s figures are released next month, which could devalue the pound against the dollar.”
Coghlan further noted that with investors amassing an extreme long GBP positioning, any signs of slowing growth and worries over a deeper recession could see stagflation fears sending the GBP sharply lower.
“The market will be carefully watching tomorrow's PMI release. If this comes in below 50 for the services and below 44 for the manufacturing, expect the GBP to sell off sharply tomorrow," he added.
HSBC bearish on GBP
Despite the pound’s move higher, HSBC has been bearish on the currency with the bank’s head of European foreign exchange research, Dominic Bunning, saying this week that weak retail sales for July published on Friday raised alarm bells over the sustainability of its rally, which hit $1.31 in July.
“The consumer resilience that we saw helping to drive the pound higher earlier this year appears to be fading slightly earlier than we expected," he said.
“We have been bullish on the pound since November last year, with a forecast it would hit $1.30. Having breached that level — briefly — last month, risks are building that it may now represent the peak in the currency rather than a more sustainable level beyond the end of the drizzly summer.”
Traders will now be turning their attention to Wednesday’s S&P Global PMI surveys of the manufacturing and services sectors for further UK economic indicators.
Manufacturing in July is expected to rise to 46.2 and services to fall to 51.2, according to IG analyst Chris Beauchamp.