UK Wage Growth Propels Pound to 15-Month High

The pound (GBPUSD=X) reached a 15-month high against the dollar on Tuesday as UK wage growth surged to 7.3%. Sterling was trading at $1.2914, up 0.4% for the day, marking its highest level since April 2022. It also climbed 0.4% against the euro (GBPEUR=X) to €1.1731.

Data from the Office for National Statistics (ONS) revealed that average pay rose by 7.3% year-on-year in the quarter leading up to May, marking the joint-highest reading on record. Economists had predicted a slight slowdown in pay growth to 7.1%.

Workers have been seeking pay increases to keep up with the rising cost of living. Despite the record increase, pay rises are still trailing behind inflation, which currently stands at 8.7%.

Russ Mould, an analyst at AJ Bell, attributed the pound's rise to the strong UK jobs data, stating that the value of overseas earnings, which dominate the index, is relatively less significant due to the pound's recent gains.

While signs of easing tightness in the labour market are emerging, wage growth remains uncomfortably high in the context of the Bank of England's (BoE) efforts to control surging prices. Mould suggested that the BoE might face challenges trying to control inflation without causing disruptions to the economy.

Private sector regular pay also reached a record high outside the pandemic period, rising 7.7% on the same basis. This surpassed the BoE's forecast for growth of 6.3% in Q2.

Meanwhile, the UK unemployment rate increased to 4% in the three months leading up to May, up from 3.8% in the previous quarter, according to the ONS.

Chancellor Jeremy Hunt highlighted the strength of the jobs market but also acknowledged the existence of around one million job vacancies contributing to inflationary pressures. He mentioned forthcoming labour market reforms, including the expansion of free childcare, to support the development of a high-wage, high-growth, low-inflation economy.

The news raises further concerns for the BoE, which aims to cool the economy and has warned about a potential price-earnings spiral. Financial markets predict a 70% chance of a 0.5% increase in UK interest rates at the BoE's next meeting in August, which would take rates to 5.5%, the highest level since late 2007. There is also a 30% possibility of a smaller quarter-point increase to 5.25%.

Analysts anticipate that the bank rate could reach as high as 6% by November and at least 6.25% by next spring. Martin Beck, chief economic advisor to the EY ITEM Club, stated that the pressure on the Monetary Policy Committee (MPC) to continue raising rates in August will be significant.

The strong wage growth in the UK has fueled optimism in the economy and pushed the pound to a 15-month high against the dollar. The record 7.3% year-on-year increase in average pay for the quarter ending in May surpassed economists' expectations. It highlighted the strong demand for higher wages to keep up with rising living costs. However, despite the impressive growth, pay rises still lag behind the current inflation rate of 8.7%.

The Office for National Statistics (ONS) data also revealed that private sector regular pay rose by 7.7%, reaching a record high outside the pandemic period. This outperformed the Bank of England's forecast of 6.3% growth in the second quarter. The robust wage growth indicates a tightening labour market, but it also poses a challenge for the Bank of England, which aims to control surging prices and avoid an overheated economy.

The UK unemployment rate rose to 4% in the three months leading up to May, up from 3.8% in the previous quarter. While the overall jobs market remains strong, approximately one million job vacancies contribute to inflationary pressures.

The positive wage growth data has increased expectations of an interest rate hike by the Bank of England. Financial markets are pricing in a 70% chance of a 0.5% rate increase at the next meeting in August, potentially taking rates to 5.5%. There is also a 30% possibility of a smaller quarter-point increase to 5.25%. Analysts anticipate further rate hikes in the coming months, with the bank rate projected to reach as high as 6% by November and at least 6.25% by spring next year.

The Bank of England's decision to raise interest rates will be influenced by its efforts to control inflation and prevent a price-earnings spiral. The outcome of the next meeting in August will be closely watched as the central bank weighs the need to cool the economy while supporting sustainable growth.

Overall, the strong wage growth in the UK has bolstered the pound, but it also presents challenges for policymakers as they seek to strike a balance between managing inflationary pressures and sustaining economic stability.