Mixed bag of employment data shouldn’t halt hawkish shift at BOE

The latest employment data for the UK had some positive and negative surprises for traders. On the plus side the UK economy continues to create jobs hand over fist. 181k jobs were created in the three months to July, the highest pace of three-monthly job growth since late 2015. However, relentless job growth in the UK has not fuelled an increase in the size of pay packets, and wage growth disappointed yet again, with the headline rate rising 2.1% vs. 2.3% expected.

Yet again, there were a record number of people in work in the UK, with 75.3% of the working age population with a job, and the unemployment rate is at its lowest level since 1975. The disconnect the tightness of the labour market and muted wage growth has been a problem that economists have tried to figure out for most of the post-financial crisis period, however, there are growing signs that wage growth is about to turn. Firstly, public sector pay growth is set to rise now that the pay cap has been lifted. Already police and prison officers have received a pay rise, this is likely to become more broad-based as we move into political party conference season later this month. Also, other reports suggest that wages are set to pick up as shortages for some workers’ force employers to offer cash incentives.

What will the BOE do?

Since wage growth is a lagging indicator, the Bank of England should look through today’s data and focus on the longer term picture for pay packets and the impact on inflation. It’s all well and good the BOE failing to shift to a hawkish bias at this week’s meeting on the back of weak wage growth, but with inflation running at 2.9%, inaction from the BOE will actually weigh further on workers’ pay packets as real wages are eroded. Thus, we maintain our view that we will see at least one more BOE member, with the potential for two, to join McClafferty and Saunders by voting for a rate hike, which would suggest the era of record low rates in the UK could be coming to a close.

The market reaction:

The pound fell sharply on the employment data, although this could be squeezing out weak longs ahead of tomorrow’s key BOE meeting. GBP/USD is continuing to fall, and is now skirting 1.3270 after hitting a high of 1.3329 ahead of the release. This decline is all data-related, so if the BOE does shift to a hawkish bias tomorrow then we would expect an about-turn from investors’ with the pound in favour once again.

Likewise, EUR/GBP has also recovered after recent declines, as the sell off takes a breather as investors digest the latest UK data. Overall, unless we see a break back above yesterday’s high at 0.9080 then we continue to think GBP could recover vs. the euro in the short term.

Sterling traders also need to be aware of interest rate markets, today’s data hasn’t dented rising expectations that the BOE could hike interest rates by the end of the year. The Overnight Index Swap market is now pricing in a 34.2% chance of a rate hike by the December, up from 20% last week. This also adds to our belief that today’s pullback in sterling should be temporary.