This week brings an important set of data for GBP/USD ahead of the BOE’s interest rate policy decision on Thursday of next week. At its last meeting, the BOE voted unanimously to keep rates unchanged and to wait to see what the data say about the impact of the war in the Middle East on the UK economy. The bulk of that data will be coming out in the coming days and is likely to set expectations for the pound and its trading pairs.
The first of the key data points came out on Tuesday, when the ONS reported that the UK unemployment rate unexpectedly dropped to 4.9%, rather than matching expectations of remaining unchanged at 5.2%. The pound gained immediately after the headline was released, but has subsequently lost all of the gains in a matter of hours. That’s because the market had time to absorb the implications of the components. In a particularly volatile environment, we should be on the lookout for similar behaviour after the upcoming data.
Why Cable Could Be Reversing
The main argument used by BOE officials who support cutting rates is that there is growing “slack” in the jobs market. That is usually represented by a high unemployment rate, as more people are looking for work than there are positions available. Over the long term, this depresses wages, as people are forced to take lower-income jobs, and keeps a lid on inflation.
That’s why even though inflation is still above the BOE’s target, the central bank could continue to lower rates. The sudden drop in unemployment seemed to counter that narrative, but it emerged that the decline was due to fewer people searching for work. This drop in the labour force participation rate is a bad sign for the economy because it suggests people feel it’s not even worth trying to find a job. This fits neatly into an argument that Governor Andrew Bailey has been making even since the start of the war in Iran.
Rate Hike Because Iran War in Doubt
There has been rampant speculation that the BOE will have to raise rates to address higher inflation driven by the energy crisis. In fact, the market is pricing in between one and two hikes this year. But Bailey has warned that the market may be getting ahead of itself, as the BOE is also concerned about economic growth and that hiking would slow the economy.
The latest data suggests that, despite the bump higher in February, the UK economy is under pressure. A slower economy generally means lower inflation, so the BOE might “look through” short-term energy inflation pressures and worry more about inflation falling below target later in the year.
What to Look Out For
That thesis could get renewed support if inflation also misses expectations. The trend in data from other countries has been that economists have overestimated the impact the war in Iran is having on inflation. This could be additionally pronounced in the UK, as more of its pricing is controlled and included in long-term contracts.
March UK CPI is scheduled for Wednesday, and is expected to accelerate to 3.3% from 3.0% a month earlier. The increase is attributed almost entirely to higher energy prices. The core rate is expected to stay unchanged at 3.2%. Later on Friday, the March Retail Sales figures are released, with a forecast to accelerate to 0.2% from -0.4% in February.
