According to the latest data from the National Statistics Bureau, the UK's unemployment rate unexpectedly decreased, which may pose a challenge to the Bank of England's interest rate cut strategy. In the three months ending in June, the UK's unemployment rate dropped by 0.2 percentage points to 4.2%, going against the economist's expectations of a slight increase. At the same time, the number of employed people increased by 97,000, far exceeding the expected 3,000.

Although the reliability of the labor force investigation is in question, investors generally regard this data as a signal of strong economy and potential inflation. The overall unemployment rate is not only lower than expected, but even lower than the Bank of England's forecast of 4.4% for the second quarter.

Against this backdrop, the pound's exchange rate rose by 0.3%, breaking through the $1.28 level, the best-performing currency in the G10. This is in stark contrast to the recent weakness in the US employment data, which has caused market anxiety in recent weeks.

Bank of England Monetary Policy Direction

Andrea Szczytkowski, the senior economist at Nomura Securities, pointed out that the UK seems not to be affected by the weak US labor market and the sluggish GDP growth in the eurozone. He believes that the data for the UK labor market and economic activity is still strong, which supports his view on the policy differences between the Fed and the Bank of England.

However, for the Bank of England, the decrease in the unemployment rate may actually increase the difficulty of lowering interest rates. Central bank officials continue to focus on wage data to look for signs of inflation, and to consider the potential driving power of the labor market for wages and prices. However, recent data shows that regular wage growth has dropped from 5.8% in the previous quarter to 5.4%, the lowest level since the summer of 2022.

Dan Hanson, an economist at Bloomberg, commented that despite the reasons to support the Bank of England's further easing of monetary policy this year, the drop in the unemployment rate may indicate that the rapid recovery of the labor market will tighten the market, which may cause the central bank to remain cautious.

Economic data to be released this week is expected to set the tone for the Bank of England's next policy decision on September 19. Investors expect the central bank to cut interest rates further in November, but central bank officials have said that they will carefully evaluate the strength of domestic price pressures.

In addition, Catherine Mann, hawkish interest rate setter at the Bank of England, warned that the upward trend of wages and prices will take a long time to eliminate. Evelyne Gomez-Liechti, strategist at RBS, also noted that the Bank of England's rate cut was primarily driven by public sector wage growth, and that private sector wage growth may be a more worrying factor for the central bank.

After the National Statistical Bureau suspended the labor force survey last year, Bank of England officials were cautious in interpreting employment data. The bureau is currently undergoing a comprehensive reform of the survey, but new data releases have been postponed until next year. The central bank expects the unemployment rate to reach 4.8% in the coming years, still below the peak during the epidemic and the financial crisis.

Ruth Gregory, deputy chief UK economist at Capital Economics, said that concerns about the accuracy of the data force the central bank to be more cautious in interpretation. Therefore, although the unemployment rate has dropped, the impact of today's data on central bank decisions may be limited.

The employment market data will play a key role in policymakers' decisions as the beginning of a series of economic data this week. In early August, the Bank of England Monetary Policy Committee voted 5-4 to lower interest rates by 25 basis points to 5%.

It is worth mentioning that due to the pound's exchange rate rise, the currency market has reduced its expectations of interest rate cuts for the remaining time in 2024, from 42 basis points on Monday to 40 basis points. The pound's upward trend helped it recover from a month-long decline, although global market volatility had led investors to reduce net long positions.

Neil Jones, a foreign exchange salesman at TJM Europe, pointed out based on the latest unemployment data that the pound is expected to further appreciate and maintain a bullish stance. He also mentioned that the upward trend of wages is a worrying signal for the Bank of England, which may not be conducive to further interest rate cuts.

As the beginning of a series of economic data this week, the employment market data will play a key role in policymakers' interest rate decisions. In early August, the Bank of England Monetary Policy Committee voted 5-4 to lower interest rates by 25 basis points to 5%.

This will be followed by Wednesday's inflation report, which is expected to show consumer price growth in July rebounding to 2.3% for the first time due to favorable energy bill factors, compared to a 2% increase in the previous two months.

Stuart Cole, chief macroeconomist at Equiti Capital, said that the Bank of England is concerned that these data may convey potential strength signals from the labor market. He predicts that the upcoming CPI data may show that inflation pressure is rising again, which may change the market's expectations for further interest rate cuts this year.