PoundSterlingLIVE - "There are some signs of the labour market cooling and we do pick that up, I pick that up, when we go round the country actually," Bank of England Governor Andrew Bailey.
Rising market expectations for the Bank of England (BoE) Bank Rate are widely cited Boom as the primary driver of the rally by Pound Sterling but they are also now at risk of creating financial instability that could ultimately leave the country and economy appearing more comparable with the biblical city of Babylon than itself.
Sterling fell widely in midweek trade but retained its gains over all other counterparts in the G10 basket for the year after also having risen against much of the G20 grouping but its outperformance is owed to troublesome inflation developments in the UK economy and the interest rate market response to them.
"A number of commentators have said this, you know, that there are two parts to it and you can see that but I'll repeat what I said at the Mansion House, and not for the first time, on Monday," Governor Andrew Bailey told a press conference on Wednesday.
"The current level of pay increases are not consistent with the inflation target and that is, you know, a fact of life," he added in reference to the Financial Stability Report July 2023.
The UK's consumer price index measure of inflation has not fallen since March and the refined measure of core inflation has actually risen since then but even more troublesome for financial stability and the economic outlook are the increases in measures of wage growth and unemployment announced this week.
The unemployment rate rose to 4% in the three months to the end of May while both main measures of wage growth also climbed, the Office for National Statistics said on Tuesday, leading interest rate swap markets to begin implying a high probability of Bank Rate being lifted from 5% to 6.5% by the early next year.
This was a continuation of a trend that dates back to the end of March but the latest increases have lifted implied rates above the peak of 6% assumed by the BoE in the stress test carried out as part of its latest financial stability review, the results of which were announced on Tuesday and briefed on Wednesday.
"We've seen that number of highly indebted households move from 1.6% of households to about 2% but it would need to move up to about 3.5% to get back to where we were in the financial crisis," Deputy Governor for financial stability Sir John Cunliffe said.
The BoE's analysis suggests that reforms implemented as a result of the crisis should mean the financial system is able to handle a Bank Rate of up to 6% but also makes clear how a continuation of the increase in unemployment announced on Tuesday could potentially throw a spanner into those works.
Employment levels are known as a 'lagging indicator' of economic health but they have been typically slow to respond to recent changes in monetary policy, unemployment is now rising and could be even quicker to rise over the coming months.
"There are some signs of the labour market cooling and we do pick that up, I pick that up, when we go round the country actually," Governor Bailey said Wednesday.
"We're going to have to put all of this information together again and see what we make of it," he added in reference to the August forecast and interest rate decision.
Joblessness leads to loan defaults compromising assets and capital reserves in the banking sector, making the labour market an Achilles heel for the economy and financial stability, both of which would be severely tested if the current upward trajectory of inflation and wage growth leads market expectations for interest rates to rise further.
But such an outcome would impact more than just the economy and financial stability because the increase in market expectations for Bank Rate has been widely cited as the primary driver of the rally by the Pound, which has gathered steam in recent months to make Sterling the top performing major currency of the year.
It's not yet clear how long it would take for these emerging risks to undermine the rally in the Pound, or how long it would be before interest rate swap market activity becomes self-defeating, though the growing risk of an accident was clear in the July financial stability report and this week's economic data.
An original version of this article can be viewed at Pound Sterling Live
