GBP/USD hits a new yearly high of 1.2913, while EUR/GBP continues to be under pressure below the range of 0.8550.

The latest UK labor market report shows a worse condition than the consensus forecast. However, this news was surprisingly well received by market participants. The GBP/USD duo hit a new yearly high of 1.2913, while EUR/GBP continues to be squeezed below the threshold of 0.8550.

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The UK's Office for National Statistics (ONS) reported that wage pressures in the UK are still very high, surpassing estimates in May 2023. The Average Earnings Index Plus Bonus accelerated from 6.7% to 6.9%. However, other details in the labor market report indicate a gradual easing of pressure.

The UK unemployment rate jumped from 3.8% to 4.0% in May 2023. Monthly unemployment claims also increased significantly by 25.7k in June 2023. This is in contrast to a decrease of 22.5k claims in May, and the previous consensus expected a further decline of 8.6k in June.

Interestingly, the pound sterling responded by strengthening against most other major currencies. What is the reason behind this?

Market participants were previously panicked by the continuously increasing inflation and labor market data in the UK, as the persistence of these factors could pressure the Bank of England (BoE) to raise interest rates to excessive levels. Excessively high-interest rates could risk household and corporate bankruptcies in the UK and worsen the threat of recession. Against this backdrop of concerns, the disappointing UK labor market report has brought fresh air.

With reduced concerns, the market is now refocusing on the competitiveness of UK interest rates. The UK will likely end its monetary tightening cycle with a higher terminal interest rate than several other major economies. This factor could positively impact the sterling, provided there are no significant negative side effects on the economy.

"Higher interest rates enhance the carry advantage of the Sterling (which is already quite good), although the likelihood of further hawkish surprises is very small," as stated by Barclays in one of their research notes, "We are becoming more positive on GBP in the short term."