Pound Stronger as Wages Grow and Bank of England Looks to First Interest Rate Rise

The British pound is the stand-out performer in global FX trade thanks to two positive domestic events.

Firstly, wages are now comfortably outstripping inflation in the UK and secondly, the Bank of England may have to start raising interest rates sooner than they, and the markets, had previously expected.

The Bank of England’s decision on interest rate levels remains the most important drivers of the value of the pound sterling.

In turn, arguably the most single most important economic determinant of Bank of England thinking on interest rates is wage growth.

The earnings power of the UK workforce has improved substantially. On the 17th of June it was shown that the Average Earnings Index +Bonus (Apr) jumped 2.7%, up from 2.3% in the previous month.

Compare this to the expectations for a reading of 2.1% and we can see why the currency markets are playing catch-up with the pound.

The Bank of England has long pointed to wage levels as being a key factor behind when they raise interest rates.

With wages rising at this pace we have the sense that the Bank will have to bring forward their first hike.

The lot of the UK worker is certainly improving as wages are now outstripping inflation by quite a margin, latest inflation data shows price growth of only 0.1%.

For much of the recession and subsequent recovery the Bank of England has pointed out that wage growth has been subdued - something that suggests the economy is not running at full capacity.

But now that slack is being pulled in significantly and we get the sense the Bank is watching.

Indeed, at the latest MPC meeting, the minutes of which were released on the same day as the wage data, it was shown that two members of the Committee are leaning to raising rates.

The minutes read:

“Committee members agreed that it was appropriate to leave the stance of monetary policy unchanged at this meeting. For two members, the immediate policy decision remained finely balanced between voting to hold or raise Bank Rate.“ 

Alex Lydall, senior trader at Foenix Partners, says he thinks Committee members will soon start backing an interest rate rise sooner rather than later:

“With deflationary fears subsiding on yesterday’s CPI print – now back into positive territory at 0.1% (y/y) – MPC doves could be in minority sooner than expected despite the unanimous MPC vote today.

“The committee has already highlighted in prior meetings that opinions differ on wage growth and productivity, and the two ‘finely balanced’ members, McCafferty and Weale, could be ‘off the fence’ in coming months and voting in favour of a hike.

“With Carney noting projections for inflation will rise more sharply than previously forecast, the step back into positive territory could deem a significant start to the balance in power shifting quickly towards the hawkish members.”

Those looking to make payments with either currency should consider locking in current rates while holding the option of exchanging at a higher rate should it be hit. Find out more about how this works.

Those looking to do spot transactions should do so remembering your bank will offer a rate with a hefty spread subtracted from it. An independent currency provider will do so closer to the market, thereby delivering up to 5% more FX in some instances, learn more.

Unemployment Falls

Also giving the pound a boost mid-week was the release of positive employment figures. It was shown that those claiming out of work benefits in the UK fell by 6.5 thousand people. We would point out that this is quite a lot fewer than markets had expected, a reading of -12K was expected.

Nevertheless, the trend is positive and the FSB see further declines.

Commenting on the news that unemployment has fallen by 43,000 between February and April 2015 compared to the three months to January, John Allan, National Chairman for the Federation of Small Businesses, said:

“Today’s labour market statistics provide cause for optimism for the UK economy through 2015. Unemployment is continuing to fall and the number of people in work has surpassed 31 million - evidence of the strong job creation intentions we've seen amongst our members for some time.

“It is also encouraging to see the recovery in real wages finally taking hold. Pay has increased by 2.7% compared to last year, far surpassing inflation. This confirms our own survey data, which also points to businesses expecting to raise wages through the year. In addition, our data suggests those raises have been justified by increasing productivity levels among our members.”

With wages growing, unemployment falling and the Bank of England taking note we remain bullish on the British pound for the remainder of 2015.