On Tuesday, UK labour data is due to be released. It is likely to be the key focus for GBP traders as the Bank of England has started to turn more dovish as the UK economy shows signs of stress. Rising costs for households, as the impact of higher interest rates is felt by mortgage owners, have all given the Bank of England reasons for caution as demand shows signs of cooling in the wider UK economy, particularly the UK’s housing market.
Last week, Bank of England’s Governor Bailey said that the bank is ‘no longer in a phase where it is clear that rates need to rise and the bank is now data-driven as policy restrictive. Furthermore, the latest CFTC report has shown pound-longs being reduced by all market participants. This means the market is growing in expectations of a lower rate path ahead for the Bank of England. It is in this context that we could see some pound volatility around the UK labour report.
Inflationary labour forces
Strong labour markets are inflationary as workers are better able to bargain for higher wages when there is less labour force available. Therefore, strong labour markets tend to lift the currency and weak labour markets tend to weaken a currency. This is a repeated pattern across most countries in a tackle to bring down inflation. You can see how average earnings have been increasing steadily over the last year.
So, this means if we see a miss in the UK labour market on Tuesday at 7 am UK time it would be reasonable to expect intraday pound selling. This will be because a miss in the data will be seen as deflationary. In other words, the Bank of England has to do less, so the GBP should fall and day traders would typically look for a strong currency on the day to pair the pound with should there be a miss in the data. In particular, investors should look out for US yields, as a fall in US yields would strengthen the JPY and, should that happen, a GBPJPY selling bias would be expected.
Major trade risks
The major risk to this outlook is that the labour data remains strong and that will keep the pressure on the Bank of England to keep hiking rates. This would mean the GBP is less likely to sell off. However, remember that the path of the GBP can always surprise market participants despite the outlook that’s anticipated. Furthermore, the path of US yields is highly uncertain at the moment, so the JPY pairing would depend on the movement of US yields on Tuesday.