Falling unemployment set to boost sterling

Unemployment in the UK is declining, as the country continues its recovery from the financial crisis. In addition, wage growth is now beginning to outstrip inflation as well. Thus, the UK economy may finally be entering a positive spiral of growth. 

Upcoming jobless figures for Britain are anticipated to reflect a continued improvement in the number of people in work; and those people will have more money to spend. Sterling has already reached two-and-a-half year highs against the US dollar, and now seems set to go through $1.70.

The most recent figure showed that unemployment had dropped through 7%, for the first time in five years. Sterling surged against the US dollar and the euro on the back of this, and since then we have seen further gains.

The rise was partially down to optimism surrounding the economic release, as well as expectations that this would prompt the Bank of England to shift closer towards a rate hike. The BoE did have 7% marked as a threshold that would trigger the first rate increase, but, as employment improved much quicker than expected, Mark Carney moved the goalposts on forward guidance, prudently realising that such a target tied him to a course of action that was clearly not yet appropriate. The UK economy may be getting better, but it has not yet attained the strength needed to sustain a rise in interest rates, with all the implications that has for mortgage rates and loans.

Since the last batch of unemployment data, the pound has come within a whisker of $1.70. It has not touched that level yet, however, as round numbers are something of a psychological barrier for traders (it makes sense for them to place stops either side of a round number, e.g. $1.6981 or $1.7011, rather than at $1.70 exactly). In due course, I expect GBP/USD to go higher, initially targeting $1.7080; the mid-2009 high.

On the downside, I think we will see short-term support at $1.6915, and then at $1.6850. The Federal Reserve is even further away from the first rate hike than the BoE is, and this fundamental dynamic should see GBP/USD test new highs in due course.

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