- UK labour market data in focus
- Buy GBP, sell EUR says Saxo
- GBP underpinned by strong inflation outturn
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Those looking for a stronger British Pound were left disappointed Thursday following the release of mixed UK labour market statistics for June.
While wage pressures continue to build and beat analyst expectations the rate of employment growth is starting to fade, according to the ONS.
The market was looking for 90K jobs to be created in the three months to June, meaning the actual figure of 25K disappointed against market expectations.
The unemployment rate meanwhile ticked up to 4.8% from 4.7% in May.
The disappointing headline jobs figures were nevertheless countered somewhat by better-than-expected wage statistics.
The Average Earnings Index, with bonuses included, rose 7.3% in May, ahead of the 7.1% expected and the previous month's 5.6%. In normal times such data would signal to the Bank of England that inflationary pressures are building and that interest rates rises might be warranted as a result.
But both compositional and base effects are contributing to the strong wage data that means the Bank will likely look through these figures and keep rates unchanged in 2021.
Yet, the ONS data also shows the number of unfilled vaccancies with employers are above pre-pandemic levels suggesting genuine labour supply shortages are building.
"May’s figures paint a picture of a labour market well on its way to recovery and will further fuel concerns about labour shortages and the possible impact on inflation of higher wage growth," says Ruth Gregory, Senior UK Economist at Capital Economics.
The Pound had risen sharply just 24 hours earlier following the release of inflation statistics that beat expectations, but gains were ultimately reversed, confirmation that there is little investor appetite to take the Pound higher.
The reversal of those gains accelerated following the labour market data and the Pound-to-Euro exchange rate (GBP/EUR) was quoted back below 1.17 while the Pound-to-Dollar exchange rate (GBP/USD) was at 1.3855.
Foreign exchange markets are currently proving sensitive to surprising economic data releases, as evidenced by the Pound's rally in the wake of stronger-than-expected inflation data out on Wednesday and the Dollars jump in the wake of strong U.S. inflation numbers on Tuesday.
The Bank of England will be watching this week's inflation and employment data carefully as it will help inform a decision as when to raise interest rates from crisis era lows.
"We think that a sustained rise in pay growth won’t take place until the second half of 2023 and that an interest rate rise is further away than the financial markets think," says Gregory.
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Those central banks that move ahead of their peers when raising interest rate can expect to see their currencies move higher, but they can only raise rates if inflation and employment are tracking higher.
Kit Juckes, Chief FX Strategist at Société Générale says if policy normalises as global economic recovery continues then expect UK rates to be increased before, and to rise faster thereafter, than Eurozone ones.
He says this should allow the GBP/EUR exchange rate to drift higher. (See more on their updated GBP/EUR forecast here).
The British Pound was bid in mid-week trade following the release of UK inflation data for June which came in hotter than expected, prompting expectations that a 2022 Bank of England interest rate rise was increasingly likely.
According to the ONS, CPI inflation rose 2.5% year-on-year in June, which is greater than the 2.2% forecast by the market and the 2.1% reported in May.
Inflation rose 0.5% month-on-month to June, which is more than the 0.2% the market was expecting but less than the 0.6% reported in May.
With June inflation readings having now come in from the world's major economies it can be seen that the U.S. is certainly seeing outsized inflation readings.
This has resulted in the market betting that the first interest rate of the next cycle at the Federal Reserve is racing forward and talk of a 2022 rate rise is now commonplace amongst analysts.
This repricing helps explain the Dollar's strong performance through the mid part of this year.
But as can be seen in the above graph, the UK is second in the inflationary stakes and the same dynamics pushing the Dollar higher are offering the Pound some support.
Economists at Deutsche Bank have assessed Wednesday's inflation statistics and concluded that the peak in inflation for the current cycle in the UK is now likely close to 4.0%.
"Our updated forecasts reflect recent trends of stronger pass-through in core goods, with our projections now revised up a full percentage point for 2021 (2.5% y-o-y). This bakes in further price gains in four categories: clothing, furniture, cars, and IT equipment," says Sanjay Raja, Senior Economist at Deutsche Bank.
This call has implications for Bank of England policy as it suggests inflation will be potentially stickier than the Bank envisages.
The pressure on policy makers to raise interest rates will therefore likely grow considerably over coming months.
Indeed, Deutsche Bank says inflation will remain well above the Bank's target throughout 2022 and it will only be in 2021 that prices fall back to the 2.0% target.
John Hardy, Head of FX Strategy at Saxo Bank, says central bank policy normalisation is now the dominant theme for currency markets and he is looking to sell the Euro against the Pound as a result.
"UK Prime Minister is expected to remove all Covid restrictions next week, which could further supercharge UK activity numbers and have the BoE pull forward its rate expectations more in line with the market’s expectation for a move early next year," says Hardy.
Hardy says the ECB is meanwhile likely to reassure markets that Quantitative Easing won’t quickly come to an end next year, which will likely be confirmed at is meeting next week.
Saxo Bank are looking to sell EUR/GBP at 0.8515 targeting a move to 0.8325.
This equates to a buy of GBP/EUR at ~1.1743 targeting a rise to 1.2012.