The British Pound (GBP) slipped after Monday’s European open, but found strong support on dips and recovered ground later in the day.
The Pound to Dollar (GBP/USD) exchange rate bounced from 1.2750 lows to trade back above 1.2850.
GBP/USD strengthened to highs near 1.2900 in Asia and traded above this level after the latest UK labour-market data.
Following the data, markets priced in over a 50% chance that the Bank of England (BoE) will again increase interest rates by 50 basis points at the August meeting.
There was, however, a retreat in the 2-year gilt yield to 5.27% as global yields declined.
GBP/USD was unable to hold above 1.2900 and traded around 1.2885.
There will be further concerns over the impact of higher mortgage rates with the 2-year rate increasing to a 15-year high.
The Pound to Euro (GBP/EUR) exchange rate found support at 1.1650 and traded just above 1.1700 on Tuesday.
UK Labour Supply Increases
The UK unemployment rate increased to 4.0% in the year to May from 3.8% previously and above consensus forecasts of 3.8%.
The ONS estimated that UK payrolls recorded a decline of 9,000 for June, the first decline for over two years.
The economic inactivity rate decreased by 0.4 percentage points on the quarter, to 20.8% in March to May 2023 with some retirees returning to the labour market.
The number of workers out of the labour force due to long-term sickness also declined for the first time this year.
The estimated number of vacancies fell by 85,000 on the quarter in the quarter to June, the 12th consecutive decline.
ONS director of economic statistics Darren Morgan commented; “Total employment grew in the latest three months while the number of people actively looking for work also increased, both driven by men rejoining the labour market.”
Kitty Ussher, chief economist at the Institute of Directors, pointed to the decline in inactivity. She added; “There is also a suggestion that recent interest rate rises are starting to feed through, with a reduction in payrolled employees and a slight increase in the historically low rate of unemployment.”
Martin Beck, chief economic advisor to the EY ITEM Club, added; “The latest data for the labour market did at least offer signs of loosening on the quantities side. Employment continued to rise, increasing by 102,000 in the three months to May on the previous three-month period. But inactivity fell back, contributing to the workforce growing 1.1% year-on-year in the three months to May.”
Wage Pressures Continue
The headline increase in average earnings strengthened to 6.9% in the year to May from 6.7% previously and above expectations of 6.8%.
Underlying earnings increased 7.3% which was unchanged from May, above market expectations of 7.1% and equalled the strongest rate since the series began.
In real terms growth in total and regular pay fell on the year in March to May 2023, by 1.2% for total pay and 0.8% for regular pay.
Yael Selfin, Chief Economist at KPMG UK, commented “Today’s data confirm that the labour market is still too hot, as pay growth remains uncomfortably high.”
Capital Economics UK economist Ashley Webb added: “With wage growth still well above the levels consistent with the 2% inflation target, this won’t ease the Bank of England’s inflation fears significantly.”
According to Webb; “Our forecast is for the Bank to raise interest rates by 25 basis points in August, from 5% now to 5.25%, but we can’t rule out another 50 basis point hike. Much will depend on June’s CPI inflation data due next Wednesday.”
PwC UK economist Divya Sridhar warned that; “this will likely mean the Bank of England will increase interest rates higher for longer.”
Following the data, markets are pricing in a 70% chance that the Bank of England will sanction a second successive interest rate hike of 50 basis points to 5.50% at the August meeting.
The remaining 30% chance is for a 25 basis-point hike. Rates are still expected to peak at 6.25% or higher.
ING expects that wages growth could moderate quickly, especially given the increased labour supply.
Nevertheless, it added; “A few months ago it looked like UK wage growth had peaked. Now it is running at its fastest pace yet, and, depending on next week's inflation figures, it could push the Bank of England into another 50bp rate hike in August.”
Danske Bank FX analyst Kirstine Kundby-Nielsen notes the importance of rate expectations; "There have been no signs of relief in the labour market data and markets continue to price in more. That's been a huge factor driving the pound,"
Retail Sales Remain Subdued
The British Retail Consortium (BRC) reported that like-for-like retail sales increased 4.2% in the year to June from 3.7% previously, but below consensus forecasts of 4.6%.
Paul Martin, UK Head of Retail, KPMG, commented; “Consumers have so far remained resilient, but the triple threats of further interest rate hikes, resolute double digit food inflation and an economy recovering at slower rate than predicted, could hamper a return to much needed profitable growth across the retail sector.”
Commerzbank maintains a negative stance towards the Pound; “The BoE remains too hesitant, and concerns about a hard landing for the economy are going to intensify, thus limiting Sterling’s upside potential. We continue to see a weakening GBP medium term as we assume that the market’s rate expectations are excessive.”
Dollar Loses Ground, Markets Looking for Peak US Rates
Federal Reserve rhetoric remained relatively hawkish on Monday, but the dollar lost ground with markets overall expecting that a July rate hike would be the last one.
The dollar index dipped to 2-month lows and the Euro to Dollar (EUR/USD) exchange rate moved above the 1.1000 level for the first time since early May.
Shaun Osborne, chief FX strategist at Scotiabank commented; "Broader pressure on the USD is likely to develop as cyclical headwinds mount and markets begin to anticipate easier Fed policy settings."
According to ING; “GBP/USD looks set to extend to 1.30 in this soft dollar environment, while EUR/GBP can retest the lows near 0.8520. (GBP/EUR above 1.1735).
MUFG added; “The pound should continue to benefit from higher UK rates in the near-term until evidence begins to emerge that the UK economy is slowing more in response to much higher rates. Cable is poised to move into the low 1.3000’s.”