Pound Sterling Slumps on 5-year Unemployment High

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The British pound dropped against the euro, dollar and other major currencies after it was revealed the UK shed jobs in January and wages cooled.

The odds of a Bank of England interest rate cut happening next month rose after it was reported UK payrolls fell 11k in January, making for a 5th consecutive monthly decline.

The unemployment rate rose to 5.2% in December, a five-year high, which disappointed against expectations for a stable reading of 5.1%. The Bank of England will also take note of today's data showing wages cooled, as this signals disinflationary trends are becoming increasingly entrenched:

Average earnings - including bonuses - fell from 4.7% to 4.2%, undershooting expectations for a drop to 4.6%. With bonuses excluded, pay fell from 4.5% to 4.2%, which met expectations.

As labour market slack opens, inflationary pressures should fade further and allow the Bank to deliver at least two more - maybe three - rate cuts this year.

This is weighing on domestic bond yields and the pound; "the market reaction has been swift. The pound has sunk on this news," says Kathleen Brooks, research director at XTB. The pound to euro exchange rate fell to 1.1460 from 1.1492 following the data and the pound to dollar exchange rate fell to 1.3525 from 1.3614.

"GBP/USD has slipped below its 21‑day moving average, putting the 50‑day near $1.3525 in view, while GBP/EUR is once again testing the key €1.1460 support zone we’ve highlighted for weeks," says George Vessey, an analyst at Convera.

"Risks to GBP could build if the labour market deteriorates more than expected with higher unemployment or if policy uncertainty returns. As the BoE cuts rates closer to neutral in 2026, we expect GBP to weaken versus G10 currencies whose policy rates are already neutral," says Paul Mackel, head of FX research at HSBC.

Sterling weakness is apparent on all the major GBP cross exchange rates as the market gives a clear thumbs-down verdict on these figures. "It is the weakest currency in the G10 FX space on Tuesday, and the pound is now trailing behind the dollar, and is the weakest currency in the G10 so far this month," says Brooks.

The outlook for the currency will stay downbeat as markets anticipate further soft data prints and a more activist response from the Bank of England.

Jonathan Raymond, investment manager at Quilter Cheviot, says hiring plans were put on hold due to the budget, and things are yet to get going again, "potentially highlighting the longer-term impacts of increased costs that businesses have faced."

"Increased minimum wage costs, national insurance contributions, business rates and concerns around the impact of the Employment Rights Act continues to show up in the data and appears to be putting a weight on the economy," he explains.

The ONS also reports the number of job vacancies has remained broadly stable since the middle of last year, but because unemployment is rising, the number of unemployed people per vacancy has increased, reaching a new post-pandemic high.

Redundancies are also showing an upward trend.

"These are worrying signs in the labour market. Rising employee costs have spurred a substitution from labour to capital. Youth unemployment hit a new high at 16.1% in the three months to December. The share of workers outside the labour market that want a job also remains elevated at 23% of the 16-64 aged economically inactive population," says Sanjay Raja, Chief UK Economist at Deutsche Bank.

The next test for sterling is the midweek release of UK inflation data, but it will require a surprisingly strong uptick in prices to shift the direction of travel in UK rates and currency.

"CPI data as expected tomorrow will reinforce our view of a March rate cut and keep the pound under downward pressure," says Derek Halpenny, Head of Research for Global Markets EMEA at MUFG Bank.

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