Pound races to a 15-month high: Record pay rises spark rate hike fears

The pound has appreciated against the dollar and the euro as rampant wage growth in the UK increased pressure on the Bank of England to raise interest rates to curb inflation.

In a report that raised eyebrows in financial markets, the Office for National Statistics said average wages in the three months to May were 7.3 percent higher than a year earlier.

Collectively, it was the largest increase since records began in 2001 and fueled fears that the UK could face a wage-price spiral that would leave inflation embedded in the economy, forcing the Bank into a series of further rate hikes.

The International Monetary Fund warned yesterday that interest rates may need to be “higher for longer” to bring inflation back under control.

With investors betting that interest rates will reach 6.25 per cent by Christmas – compared to just 0.1 per cent two years earlier in December 2021 and 5 per cent today – the pound rose to $1.2934 before easing.

It was the first time since April last year that the pound had breached $1.29, underscoring its status as the best performing major currency against the dollar in 2023 – up nearly 7 percent.

The pound is up more than 25 percent since crashing towards $1.03 last fall in the wake of the mini-budget, when Liz Truss was briefly prime minister and Kwasi Kwarteng her chancellor.

Sterling also reached €1.1758 against the single currency – its highest level since August.

Government bond yields – a measure of what it costs the government to borrow – also rose higher.

Returns on pounds and gilts have risen as traders bet that the Bank has more to do to curb inflation than other central banks.

Jane Foley, head of currency strategy at Rabobank: ‘The payroll data indicated that the bank has more work to do. Inflationary pressures are still in the pipeline.’

Governor Andrew Bailey this week said inflation remained “unacceptably high” at 8.7 percent – well above the 2 percent target – and urged the bank to “get the job done.”

But Federal Reserve officials said while interest rates in the US are likely to rise again, they are now close to their peak, pushing the dollar lower as the pound strengthens.

There is now a 70 per cent chance of UK rates rising by 0.5 percentage point to 5.5 per cent next month, according to financial market bets.

Interest rates are then expected to be 5.75 percent in September, 6 percent in November and 6.25 percent in December.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, said: ‘The persistent wage spiral has set the stage for another rate hike by the Bank of England in August, the only blunt tool it has to reduce demand in the economy. , reduction in activity, price increases and wage increases.

The pound rallied against the dollar to reach $1.29 as further interest rate hikes are expected in the UK, while inflationary pressures in the US appear to be fading faster.

But some of those gains have been wiped out as investors assess the longer-term implications for the UK economy.”

The IMF said yesterday: “Should inflationary pressures show signs of persisting, policy rates may need to be raised and held higher for longer to sustainably lower inflation and keep inflation expectations anchored.”