British Pound Rises after UK Unemployment Holds Lowest Level Since 1975 but PM May's Brexit Test Looms

-GBP advances on G10s after strong UK labour market report in April.

-Unemployment holds at joint lowest since 1975 and wages rise 2.5%.

-But GBP perched on precipice as PM May faces key Brexit votes.

© IRStone, Adobe Stock

Pound Sterling erased earlier losses and advanced against the developed world currency basket Tuesday after the latest labour market report showed the UK economy continuing to create new jobs at a rapid clip in April, keeping the unemployment rate at a multi-decade low. 

The UK unemployment remained at 4.2% in the three months to the end of April, its joint lowest level since 1975, and the number of welfare claimants posted a surprise 7,700 fall. Meanwhile, average weekly earnings rose by 2.5% during the period, when bonuses are included, which is down from 2.6% in March but in line with economist expectations. 

There were 146,000 more people in work during the three months to the end of April than there were in the period leading up to the end of January, and 440,000 more in work when the quarter to the end of April 2018 is compared with the same period one year ago, suggesting the UK labour market remains in robust condition. 

There were 1.42 million people classed as unemployed during the period, 38,000 fewer than in the three months to the end of January and 115,000 fewer than there were one year ago.

The youth unemployment rate, which covers those between the ages of 16 aqnd 24 years old, was 11.9% during the recent period. This is down from 12.5% one year ago and not a long way off from the all-time low of 11.6% seen in May 2001. 

"Another strong set of labour market figures in April suggests that firms remain positive about the outlook for demand despite the economy going through a soft patch at the start of the year," says Andrew Wishart, an economist at Capital Economics. "As long as economic activity holds up, we still think that the MPC will press ahead and increase Bank Rate in August."

Markets care about the labour market data because of the influence that changes in unemployment and wages can have on inflation, in that lower unemployment and faster wage growth means greater demand within an economy and higher inflation further down the line. Accordingly, this has implications for interest rates at the Bank of England because it is inflation that central banks are attempting to manipulate when they tinker with rates.

"Total hours worked fell by 0.4%. Admittedly, the hours worked data are more volatile than the employment figures and bad weather in February and March might have prevented people from getting to work," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. "Even so, measures of employment growth from the Markit/CIPS, REC/KPMG and E.C. surveys all have weakened this year."

Tombs says the falling number of hours worked is a sign that UK labour market growth is weakening and that this could prevent the Bank of England from raising interest rates in August, which would be bad for Pound Sterling.

The Pound was quoted 0.25% higher at 1.3404 against the US Dollar following the release Tuesday, after extending an earlier 0.15% gain, while the Pound-to-Euro rate converted a 0.10% loss into a 0.04% profit to trade at 1.1361. 

Sterling was also higher against all other developed world currencies barring the New Zealand Dollar and Scandinavian units.  

Tuesday's labour data comes as Prime Minister Theresa May prepares to face a series of key votes in parliament that will either make or break the government's Brexit strategy. 

It also follows hard on the heels of Office for National Statistics data released Monday, which showed UK manufacturing and industrial production posting a surprise fall during the April month, suggesting the economy entered the second quarter of the year on the back foot. 

It was hoped the second quarter would bring a rebound in UK economic growth after GDP growth slowed from 0.4% in the final quarter of 2017 to just 0.1% during the first-quarter, as poor weather during the February and March period hit both retail sales and construction activity.

A recovery in growth, as well as smooth Brexit process, will be key to rejuvenating UK inflation and interest rate expectations during the months ahead. Pricing in interest rate derivatives markets currently implies there is a less-than 20% probability of a UK interest rate rise in August.

This is a deterioration from the situation that existed at the beginning of April, when the implied probability of a rate hike having been announced by the August 02 Bank of England (BoE) meeting was more than 80%, which owes itself to a faster than expected fall in the rate of UK inflation during 2018 and economic weakness at the start of the year.

"What might get even more attention today though will be the start of debate and voting on 15 amendments to the Brexit bill that in the House of Commons beginning at 12:30pm. Votes today will include the "Meaningful Vote" amendment, which will likely be decided by rebels on both sides of the floor," says Jacqui Douglas, chief European macro strategist at TD Securities.  

Prime Minister Theresa May faces a series of votes Tuesday on whether to approve 15 “Brexit wrecking” amendments inserted into the EU Withdrawal Bill by the House of Lords, which will set the government's Brexit strategy in legislative stone.

If PM May loses the votes, which some reports have suggested she might, then the UK will be required by law to remain a member of the EU single market and customs union. The House of Commons will also gain the power to send May back to the negotiating table if MPs are not happy with the final deal negotiated by the government.

Such an outcome could reduce the prospect of a so called hard Brexit, where the UK leaves the EU in March 2019 without any arrangements for future trade in place, and boost Pound Sterling in the short term but it may also dramatically raise the prospect of a challenge to PM May’s leadership.

That latter consequence would heighten the risk of another general election being called and, according to some, raise the prospect of a Labour Party government which would also be a severely negative development for Pound Sterling.

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