Pound hits 17-month high against Euro as rate expectations rise, 'stretched positioning'

The pound rose a full cent against the dollar on Tuesday, and climbed to fresh 17-month highs against the euro, following the release of yesterday’s jobs data. After a rotten couple of years, we are finally seeing early signs that the cooling in Britain’s labour market may be bottoming out. Unemployment unexpectedly fell in the three months to August, wage growth ticked higher, and payrolled employment has now risen in each of the past two months for the first time since January.

Welcome as these developments are, we would caution against getting carried away. Conditions remain fragile, and while the Bank of England is almost certain to hike in November, we see no clear rationale for it to tighten aggressively beyond then, if at all.

Admittedly, today’s inflation beat raises the possibility of a second hike in February, but we are reluctant to commit to that without clearer evidence of second-round effects, which so far remains inconclusive. By contrast, markets are pricing in more than 100 basis points of MPC hikes over the next twelve months, which strikes us as extraordinary.

This upward repricing in rates, and easing fears ahead of next week’s budget, are providing solid support for sterling. News that the Chancellor Healey has ruled out hikes to capital gains tax, in favour of less growth-damaging revenue raising measures, has been particularly welcome.

Yet with sterling positioning now stretched, there is room for a sharp downside move should Healey announce measures that damage growth without delivering a credible path to fiscal sustainability.