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

The pound has raced higher against the dollar and the euro as rampant wage growth in the UK piled pressure on the Bank of England to raise interest rates to tame inflation.

In a report that raised eyebrows on financial markets, the Office for National Statistics said average pay in the three months to May was 7.3 per cent up on a year earlier.

It was the joint-biggest increase since records began in 2001 and fuelled fears the UK faced a wage-price spiral that would leave inflation embedded in the economy – forcing the Bank into a string of further rate rises.

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

With investors betting that rates will hit 6.25 per cent by Christmas – up from just 0.1 per cent two years earlier in December 2021 and 5 per cent today – the pound jumped as high as $1.2934 before easing.

It was the first time sterling has topped $1.29 since April last year, and underlined its status as the best performing major currency against the dollar in 2023 – up nearly 7 per cent.

The pound is up more than 25 per cent since it crashed towards $1.03 in the wake of the mini-Budget last autumn when Liz Truss was briefly Prime Minister and Kwasi Kwarteng was her Chancellor.

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

Gilt yields – a measure of what it costs the Government to borrow – also edged higher.

The pound and gilt yields have been driven higher as traders bet the Bank has more to do to tame inflation than other central banks. 

Jane Foley, head of currency strategy at Rabobank, said: ‘The wage data indicated there is more work to do for the Bank. Inflationary pressures are still in the pipeline.’

Governor Andrew Bailey said this week that inflation remained ‘unacceptably high’ at 8.7 per cent – well above the 2 per cent target – and insisted the Bank must ‘see the job through’.

But Federal Reserve officials said that while rates are likely to rise again in the US, they are now close to their peak, sending the dollar lower just as the pound strengthened.

There is now a 70 per cent chance that interest rates in the UK will rise by 0.5 percentage points to 5.5 per cent next month, according to bets on financial markets. 

Rates are then expected to hit 5.75 per cent in September, 6 per cent in November and 6.25 per cent in December.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, said: ‘The stubborn spiral of wages has set the scene for another interest-rate hike from the Bank of England in August, the only blunt tool it has to lower demand in the economy, reduce activity, price increases and wage growth. 

The pound rose sharply against the dollar, hitting $1.29 as further interest rate hikes are expected in the UK, while inflationary pressures appear to be easing more quickly in the US. 

But some of those gains have been erased as investors assess longer-term implications for the UK economy.’

The IMF said yesterday: ‘Should inflationary pressures show signs of further persistence, the policy rate may have to be raised and need to remain higher for longer to durably lower inflation and keep inflation expectations anchored.’