British Pound Sterling Tomorrow: Forecasters at UniCredit Bank Warn of UK Unemployment Falling to 7.2%

By Gary Howes

Things start getting interesting for the British pound as the Bank of England communicates its thinking to markets and the ONS releases the latest set of UK employment figures.

Markets have taken the pound sterling (GBP) higher through the course of Tuesday's trading session in anticipation of a positive surprise.

In late afternoon in London we see the pound dollar exchange rate trading 0.22 higher at 1.6464 while the pound euro exchange rate is 0.33 pct up at 1.2163.

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Will the UK unemployment rate surprise markets?

Tomorrow's big event is the release of the UK unemployment rate. The bank of England is targeting a rate at 7% before considering raising interest rates.

Daniel Vernazza, UniCredit Bank's UK economist expects that the unemployment rate will fall to 7.2%, lower than consensus expectations of 7.3%. At the same time he expects that the BoE minutes will have included a prominent line that low rates will likely remain on hold, even after the unemployment rate hits the MPC's threshold of 7%.

Additionally, with inflation now on target and exports looking increasingly dismal, he thinks that the bank will say that further sterling appreciation is a risk to the strength and balance of the recovery.

After all, since the previous meeting in December (when the BoE expressed for the first time its discomfort about further appreciation) and up until the latest meeting on the 8-9th of January, the BoE effective sterling index has risen by around 1.5%, something which should amplify concerns, at least at the margin.

How will the pound sterling react to a positive surprise?

If the unemployment rate falls to 7.2%, as UniCredit expect, this will be unequivocally GBP positive.

However, whether this translates into longer-term gains for the British pound remains to be seen.

FX strategist Vasileios Gkionakis at UniCredit bank is predicting the GBP will eventually start to slide against the US dollar:

"The complication arises due to the simultaneous release of the minutes. The dovish tone that the BoE is likely to have adopted regarding the time horizon that rates will stay low alongside any reference to the risks that an appreciating sterling poses to growth should offset the positive impact from the lower unemployment rate.

"In fact, because central bank verbal intervention tends to have a meaningful negative effect on currencies (at least in the short term), we think that the net impact on GBP in the immediate aftermath will be negative with the currency breaking below 1.64 and testing the 1.6350 or even below.

"We also remain comfortable with our 1.59 forecast for the 1Q14 because 1. sterling has a negative beta to US 10Y yields which should rise further from current levels on the back of Fed's tapering and 2. too much optimism is already built into the price of GBP while the bar for actual data to beat consensus expectations has been raised significantly."

KBC Markets give their view ahead of tomorrow's Bank of England MPC minutes saying they are looking forward to hearing what the Bank of England's thinking on rate rises is:

"The Minutes might be interesting. This might provide an indication whether Carney and Co are still mulling a change in forward guidance (lowering the reference unemployment rate). We are no fan of such a scenario, but the uncertainty on the issue might hamper a new up-leg in EUR/GBP.

"So, even if EUR/GBP would go for a test of the 0.8325 support, we will probably have to wait for confirmation till tomorrow. That said, we expect the pressure in EUR/GBP to remain to the downside, especially as EUR/USD is struggling, too."

Remember both the release of the minutes and the release of the unemployment numbers come out at 09:30, expect heightened volatility at this time!