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Pound Sterling extended gains against the Euro and Dollar after the UK government said it would hike the UK minimum wage by an inflation-busting amount in 2024, which pushes back the odds of Bank of England rate cuts starting in the first half of 2024.
The Pound made a push higher following the surprise announcement by the UK Chancellor, Jeremy Hunt, late on Tuesday.
Hunt said the minimum wage is to increase by more than a pound to £11.44 per hour from April next year. He also decided the rate would apply to 21 and 22-year-olds for the first time.
The Treasury said this is the biggest-ever increase to the National Living Wage, worth over £1,800 a year for a full-time worker.
This represents a fiscal impulse that risks slowing the descent of inflation, meaning the Bank of England might have to maintain interest rates at higher levels for a longer period, which is, on balance, supportive of Sterling.
"The prospect of a short-term loosening in fiscal policy - through tax cuts or spending increases now and in next spring’s budget - would probably prevent the Bank from imposing any interest rate cuts in 2024 and could even lead to another rate rise next year," writes Mehreen Khan, Economics Editor in Wednesday's edition of the Times.
Rising bond yields and a firmer Pound suggest this is the sense markets are getting from recent developments: The Pound to Euro exchange rate rose by half a per cent on Tuesday, making for its largest single-day gain since July, hitting 1.1480.
"We think some looser fiscal policy will be welcomed by sterling at this juncture," says Chris Turner, head of FX analysis at ING Bank, who favours EUR/GBP trading back below 0.8700 (GBP/EUR back above 1.1490).
Above: GBPEUR at 30-minute intervals.
The minimum wage policy announcement comes ahead of Chancellor Hunt's Autumn Statement, which will see the chancellor outline the government's latest tax and spending decisions.
Analysts say any growth-boosting announcements made by the Chancellor could support Pound Sterling.
Hunt has limited space to deliver any major tax cuts or spending increases, given the limited space in the country's accounts.
But, UK inflation has more than halved since January and the recession forecasts for 2023, made a year ago, have not come to pass.
This year’s budget deficit is also coming in far below the forecast made by the Office for Budget Responsibility at the time of the March budget.
"All this means is that, compared to the position in March, the Chancellor now has a little more room to consider some policy changes," says Rhys Herbert, an economist at Lloyds Bank. "With clearer evidence that inflation is now falling rapidly, any new stimulus measures are less open to the criticism that it will undermine BoE policy."
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Also supporting Pound Sterling is the Bank of England's Governor Andrew Bailey, who has continued to push back against rising market bets for interest rate cuts.
In a scheduled testimony to UK lawmakers following November's Monetary Policy Report, Bailey said it was sensible now to keep rates where they are.
Monetary Policy Committee (MPC) member Catherine Mann was also present, warning that the prospects of more persistent inflation imply a need for tighter monetary policy.
The MPC's Dave Ramsden said he would not rule out having to raise Bank Rate further in the future.
This was a broadside salvo by the Bank against rising bets that the Bank had completed the rate hiking cycle and that the next move would be a rate cut.
The messaging helped support UK bond yields relative to elsewhere, in turn providing the Pound with a boost.