Image © Bank of England
Britain's labour market report was firm enough to allow pound sterling to keep an eye on surging borrowing costs.
The British pound faces two-way action against the euro and dollar amidst worrying rises in borrowing costs that see the cost the government borrows at rise to the highest levels in decades.
"The rise in interest rates is directly linked to the deteriorating situation in energy prices, a trend that only looks set to continue," says Marcus Widén, an analyst at SEB.
The surge is linked to the rising cost of oil and gas owing to the deterioration in the Middle East conflict, which means the pound isn't impacted in isolation, making for a diverse set of developments across the FX strip:
- The pound-to-euro trades higher at 1.1680, benefiting from a 0.25% gain on Monday.
- The pound-to-dollar rate trades lower at 1.3470, with Monday seeing a 0.20% drop and Tuesday adding to the losses by 0.22%.
What these two exchange rates are telling us:
1) The euro is finding the going particularly difficult. The GBP/EUR gain on Monday reflects the sizeable fall in EUR/USD, which is linked to the surge in European gas prices. We have seen on a number of occasions since the war in the Middle East started that the euro is particularly sensitive to the conflict.
The Eurozone has a bigger industrial and manufacturing base than the UK does, meaning the surge in gas prices is particularly difficult.
"The rising price of gas has contributed to pushing up electricity prices in Europe," says Widén. "European gas prices are above EUR 80/MWh."
2) The dollar is benefiting because the U.S. is less exposed to the evolving global energy squeeze. The U.S. is a net exporter of oil and gas, meaning higher prices are supportive of the country's balance of payments.
There will also be some safe-haven flows that benefit the dollar as global investors take cover.
The Eye-watering Surge in Borrowing Costs
The British ten-year gilt rose to 5.439% on Monday, the highest since 2007, beyond the 5.576% peak of 2007 is the 1998 high at 5.862%.
For mortgage holders, the key concern rests on the 5-year gilt, which tends to price mortgages, here borrowing costs have surged to 5.037%, the highest since 2011.
The two-year bond yield is interesting as it is more of a reflection of Bank of England policy decisions: it rose to 5.013%, the highest since 2023. This move will reflect a surge in expectations that the Bank will raise rates on more than three occasions in the next 12 months.
The Key Concern for Sterling is the Budget Impact
The rise in borrowing will send a severe warning to Andy Burnham's government that there's no room to play with: any spending commitments will have to be funded by new taxes and borrowing.
That's a risky prospect for the Prime Minister, who might be tempted to push forward with some of his big-ticket spending commitments.
The window in which the Office for Budget Responsibility measures the bond market yields will start in early October, meaning there is still some hope that yields will retreat from recent highs and give him some spending headroom.
Pound Sterling Live's Expectation
Is that Burnham will consider testing the bond markets as being too politically risky, prompting him to opt for a low-risk budget that doesn't deliver any meaningful changes to the spending and borrowing trajectory.
He will instead opt for further gimmicky low-cost giveaways that will reflect well in the headlines but will be more or less neutral on the fiscus.
If so, the pound will avoid a major pitfall and can continue to benefit from the UK's robust economic fundamentals and elevated relative bond yields.
UK Jobs Data: Confirmation the Worst is Over, But No Smoking Gun for Bank of England
The UK economy was in focus on Tuesday, as labour market figures showed the deterioration of the past two years continues to fade.
Britain's unemployment rate holds steady at 4.9%, but there are still signs of weakness, with vacancies decreasing by 8K to 702K in the three months to August 2026.
Regular wage growth in the three months to July 2026 remained at 3.5%, excluding bonuses.
Including bonuses, the rate was 3.9%.
"Payrolls fall cements a hold from the MPC this week, but slack is building too slowly to prevent later rate hikes," says Rob Wood, Chief UK Economist at Pantheon Macroeconomics.
The Bank Consensus, Without the Terminal
The median, mean, highest and lowest from the October survey update, plus named point forecasts out to 2027.
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