UK Employment Data Disappoints but Pay Growth Starts to Gain Traction

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Wednesday’s data comes at a time when the unemployment rate has held at a 42 year low for five months and wages have seen their longest run of uninterrupted growth since before the financial crisis.

The Pound edged lower against its peers midweek following the release of labour market data from the ONS which showed the UK unemployment rate rising for the first time since July 2015.

UK unemployment rose 10 basis points to 4.4% for the three months to the end of December, according to the ONS report, when economists had expected it to hold steady at its 42 year low of 4.3%.

The unemployment rate however rose largely because more inactive people entered the jobs market, so the headline is not as bad as it initially appears.

The 46,000 rise in the number of unemployed people combines with an increase in the “participation rate”, which saw the number of inactive workers fall by 109,000 during the period.

Nevertheless, the Pound-to-Euro exchange rate dipped to 1.3944 while the Pound-to-Dollar exchange rate was seen lower by 0.33% at 1.3918.

Don't be too alarmed by the rise in unemployment (it was driven by a surge in the workforce, not falling employment). High job vacancies and business surveys suggest employment will continue to rise at a healthy rate this yr pic.twitter.com/X3liSxTRmV

— Samuel Tombs (@samueltombs) February 21, 2018

While the poorer-than-expected unemployment rate may have caught the eye of traders, the full ONS report shows the number of people in work in the UK during the period actually increased by 88,000, to 32.15 million, suggesting the economy is still creating jobs at a healthy clip.

“The strong set of labour market figures should dispel concerns that the recent weakness was a sign of things to come. Employment rose by a solid 88,000 in the three months to December, leaving the annual rate at a still-strong 1%,” says Ruth Gregory, a UK economist at Capital Economics.

“Admittedly, this was below the consensus expectation for a larger 173,000 increase and a rise in the participation rate pushed the unemployment rate up from 4.3% to 4.4%. However, pay growth seems to be starting to benefit from the recent strength of jobs growth at last.”

Separately, the ONS said that average weekly earnings rose by 2.5% on an annualised basis during the three months to the end of November, marking the third consecutive month of 2.5% growth.

Strong jobs growth and higher wages both point to rising inflation during the quarters ahead, which is something the Bank of England is growing increasingly intolerant of and that could also benefit the Pound in the months ahead.

Brexit Concerns Weighing on the Pound?

Wednesday morning’s fall in in the Pound was broad-based, encompassing Sterling exchange rates across the entire developed world currency basket.

While a significant portion of the Pound’s weakness undoubtedly occurred in the wake of the December employment report, some strategists had already flagged a bias to the downside regardless of which way the latest data went.

“A positive surprise in the wage data would see odds of a near-term rate hike trickle higher – although we note that despite the increased sensitivity of short-term UK rates to data surprises, to some degree there still remains a ‘Brexit factor’ in markets that may inhibit a normal reaction to any positive data,” wrote Viraj Patel, an FX strategist at ING Group, in a note Wednesday.

“Yet yesterday’s positive market reaction to news that the EU are willing to take a more ‘flexible’ approach to trade talks shows the potential for deferred GBP upside in the event of a constructive outcome at the 22-23 March EU leaders summit.”

The Pound has traded with a downward bias against the Dollar and Euro throughout much of February, after a strong run in the previous month, while Patel flags that a Brexit transition agreement will need to be reached in in order for the uptrend to resume.

“There are now two types of Brexit agreements that hold the key to further GBP gains: a transition agreement and an association agreement (which is the EU offering the UK a ‘privileged’ post-Brexit relationship). In theory, this is good news – but GBP will need to see pen to paper on these ‘agreements’ before moving significantly higher.”

ING forecast Sterling will move back toward 1.45 against the Dollar and potentially as high as 1.1627 against the Euro before the end of March, assuming that an amicable transition agreement is reached before the European Council summit of March 22.

Bank of England to Raise Rates Again?

Wednesday’s data comes at a time when the unemployment rate has held at a 42 year low for five months and wages have seen their longest run of uninterrupted growth since before the financial crisis.

The BoE warned in February that if the inflation outlook evolves in line with its latest set of forecasts over the coming months then it could raise interest rates at a faster pace than it had previously led markets to belief.

It already hiked the Bank rate by 25 basis points in November, to 0.5%, after inflation rose above the 3% threshold. Consumer price growth has remained at 3% ever since, when the Bank of England’s target is 2%.

Markets are now betting the BoE will raise rates at least once this year while pricing in interest rate derivatives markets, which enable investors to protect themselves against changes in interest rates, currently implies around a 50% probability of two rate rises from the BoE in 2018.

The central bank would raise interest rates in order to reduce inflation over a two-to-three year horizon. Higher rates would be expected to reduce inflation by sapping demand from the economy, although they would also boost the Pound, which would then further reduce inflation by making imported goods cheaper to buy.

Wednesday will see Bank of England governor Mark Carney appear before the Treasury Select Committee in Westminster to answer questions about the Bank's latest inflation report. 

"The BoE may feel the need to interject and thus we would expect Governor Carney and his colleagues to reiterate their hawkish stance when they testify to Parliament later today (1415 GMT) – which should, ceteris paribus, keep the implied markets odds for a May BoE rate hike just where they are (55-60%)," says ING's Patel, referring to the market reaction to Wednesday's unemployment data.

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