Wednesday 22nd January 2014
We have seen another spike in the value of Sterling this morning, after the latest UK Unemployment figures were better than forecast. It is the biggest quarterly drop in unemployment on record! As such it has pushed the Pound to a 1 year high against the Euro (€1.2215) and close to a multi-year high vs the US Dollar ($1.6550).
The figures released at 09:30am showed that the UK unemployment rate has dropped to 7.1%. This is now very close to the point at which the Bank of England has said it will consider raising interest rates.
The better than expected figures has surprised the markets, as many analysts did not expect the unemployment rate to hit 7% until much later this year or possibly even 2015. This significant fall in unemployment therefore means that higher interest rates could be on the cards.
So why has this caused the Pound to rise?
Higher interest rates in the UK mean a higher return for investors, and so the possibility of higher rates means people buying Sterling, which in turn gives it strength and pushes exchange rates higher. The effect was almost immediate as you can see from the chart below, with GBP/EUR rates rising above €1.22 which is the highest since this time last year.
Will the Pound rise higher still?
It may do if economic figures continue to impress, however I think much will depend on what the Bank of England have to say on the matter in the coming weeks. Also released this morning was the latest minutes from this month’s meeting of the Bank of England’s Monetary Policy Committee (MPC) which you can read here.
These seem to indicate that the BoE may be in no rush to raise rates, despite the low unemployment figures. This is because of the low inflation numbers I wrote about recently. Given that inflation has returned to the 2% target rate last month, and that “cost pressures were subdued… members therefore saw no immediate need to raise the Bank rate even if the 7% unemployment threshold were to be reached in the near future”, the notes said.
The MPC also said “it was likely that the headwinds to growth associated with the aftermath of the financial crisis would persist for some time yet”, reinforcing the fact it is in no rush to raise rates.
So while right now the markets seem to be expecting higher rates, the BoE have clearly indicated that even if unemployment falls further, it doesn’t necessarily mean interest rates will change. So watch closely for the next round of comments from the BoE, and if they again indicate no rate rise is on the cards, we could see Sterling weaken off again.
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