GBP/EUR: UK Wages Jump Closing the Gap on Inflation

17.08.17
3 minute read
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Stronger than forecast UK job market data on Wednesday helped pick the pound off its worst 2017 levels versus the euro. The news overshadowed solid economic growth projections for the eurozone, boosting the pound euro exchange rate briefly back above €1.10. However, the pound was unable to maintain these levels and by early evening had declined to its current value of €1.0950 versus the euro.

Unemployment unexpectedly fell from 4.5% to 4.4%, its lowest level since 1975. Meanwhile average earnings in the UK climbed to 2.1% in June, significantly higher than the 1.9% that had been anticipated by analysts. Wage growth is finally closing the gap on inflation, which was at 2.6% in June.

These results boosted demand for the pound because the lacklustre wage growth so far has been one of the principal factors preventing the Bank of England (BoE) from raising interest rates. Yesterday’s acceleration in wage growth will cause inflation to rise in the future, which increases the chances of the central bank hiking interest rates soon.

How does strong jobs data boost the currency?
It works like this, when there's low unemployment and high job creation, the demand for workers increases. As demand for workers goes up, wages for those workers also go up. Which means the workers are now taking home more money to spend on cars, houses or in the shops. As a result, demand for goods and services also increase, pushing the prices of the goods and services higher. That’s also known as inflation. When inflation moves higher, central banks are more likely to raise interest rates, which then pushes the worth of the currency higher.

Investors will now turn their attention to retail sales data due this morning. This data should give an indication as to whether the squeeze on households caused by the increased cost of living and falling wages in real terms (once inflation is accounted for) is preventing the consumer from spending. A weaker than expected 1.2% increase in the value of retail sales in July, could weigh on the pound and pull the pound euro exchange rate to fresh year to date lows.

Will eurozone inflation pull the euro lower?

News that the eurozone economy grew at 2.2% in the second quarter failed to boost demand for the euro above that for the pound. Growth outpaced analysts’ expectations and shows that the economic recovery in the euro bloc is firmly on track. However the data did little to inspire traders.

It wasn’t until much later in the session that the mood for the euro improved. The euro tends to trade inversely to the dollar and a fall in demand of the buck saw investors flock to the euro.

Today is a busy day for euro traders with the release of inflation data and details from the European Central Bank (ECB) policy meeting. Investors will be watching closely to see whether eurozone inflation has managed to tick up towards the ECB target of 2%. The closer to the 2% target, the more likely the ECB will raise interest rates, which would heighten demand for the euro.

Why do raised interest rates boost a currency’s value?
Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Higher interest rate environments tend to offer higher yields. So, if the interest rate or at least the interest rate expectation of a country is relatively higher compared to another, then it attracts more foreign capital investment. Large corporations and investors need local currency to invest. More local currency used then boosts the demand of that currency, pushing the value higher.
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