UK unemployment rate unexpectedly drops sharply, pound surges challenging central bank's rate cut path, market focuses on Wednesday's inflation data

According to the latest data from the UK National Statistics Office obtained by Zhitong Finance APP, the UK unemployment rate unexpectedly decreased, posing a challenge to the Bank of England's interest rate reduction strategy. In the three months leading up to June, the UK unemployment rate dropped by 0.2 percentage points to 4.2%, contrary to economists' expectations of a slight increase. At the same time, the number of employed people surged by 97,000, far exceeding the expected 3,000. Figure 1 Although there are doubts about the reliability of the labor force survey, investors generally view this data as a signal of a strong economy and potential inflation. The overall unemployment rate is not only lower than expected but even lower than the Bank of England's forecast of 4.4% for the second quarter. Against this backdrop, the pound sterling rose by 0.3%, breaking through the $1.28 mark, becoming the best-performing currency among the G10 countries. This stands in stark contrast to the recent weak employment data in the United States, which has caused market unease in recent weeks. Bank of England's Monetary Policy Direction Andrea Shchepaniak, senior economist at Nomura Securities, pointed out that the UK does not seem to be affected by the weakness in the US labor market and the lackluster GDP growth in the Eurozone. He believes that the data on the UK labor market and economic activity remains strong, supporting his view of divergence in policies between the Federal Reserve and the Bank of England. However, for the Bank of England, the decrease in the unemployment rate may actually increase the difficulty of lowering interest rates. Central bank officials continue to monitor wage data to look for signs of inflation and consider the potential driving force of the labor market on wages and prices. However, recent data shows that regular wage growth has dropped from 5.8% in the previous quarter to 5.4%, the lowest level since the summer of 2022. Figure 2 Bloomberg economist Dan Hanson commented that although there are reasons to support further monetary easing by the Bank of England this year, the decrease in the unemployment rate may indicate that the rapid recovery of the labor market will lead to a market tightening again, which could prompt the central bank to remain cautious. Economic data to be released this week is expected to set the tone for the Bank of England's next policy decision on September 19. Investors anticipate a further rate cut in November, but central bank officials have stated that they will carefully assess the strength of domestic price pressures. Furthermore, Bank of England hawkish rate-setter Catherine Mann warned that the upward trend in wages and prices will take a long time to dissipate. Credit Suisse strategist Evelyne Gomez-Liechti also pointed out that the Bank of England's interest rate cuts are mainly driven by public sector wage growth, while private sector wage growth may be a more concerning factor for the central bank After the UK National Statistics Office suspended labor force surveys last year, Bank of England officials are cautious about interpreting employment data. The Statistics Office is currently undergoing a comprehensive reform of the survey, but the release of new data has been postponed until next year. The central bank expects the unemployment rate to reach 4.8% in the coming years, still below the peak levels during the pandemic and financial crisis. Ruth Gregory, Deputy Chief UK Economist at Capital Economics, expressed concerns about data accuracy, leading the central bank to interpret the data more cautiously. Therefore, despite a slight decrease in the unemployment rate, today's data may have limited impact on central bank decisions. Market Focus on Wednesday's Inflation Data It is worth noting that the currency market reduced expectations of interest rate cuts for the remainder of 2024 due to the rise in the pound exchange rate, dropping from 42 basis points on Monday to 40 basis points. This rise in the pound helped it recover from a month-long decline, although global market volatility had led investors to reduce net long positions. TJM Europe's forex salesman Neil Jones pointed out based on the latest unemployment data: "The pound is expected to further appreciate and maintain a buying bias." He also mentioned that the rise in wages is a worrying signal for the Bank of England, which may not be conducive to further rate cuts. As the start of a series of economic data this week, labor market data will play a crucial role in policymakers' decisions on interest rate direction. In early August, the Bank of England's Monetary Policy Committee voted 5-4 to cut rates by 25 basis points to 5%. Next up is Wednesday's inflation report, with consumer price growth in July expected to rise for the first time to 2.3% as the favorable factors from energy bills fade, compared to 2% in the previous two months. Stuart Cole, Chief Macro Economist at Equiti Capital, stated that the Bank of England is concerned that these data may signal underlying strength in the labor market. He predicts that the upcoming CPI data may show a renewed increase in inflation pressure, which could change market expectations for further rate cuts this year