Sterling was under pressure on Wednesday after higher UK unemployment cast doubt over the prospect of a near-term rate hike from the Bank of England (BoE).
The pound was down by about 0.6% and 0.4% against the dollar and euro respectively as at 1200 GMT.
However, the official data released by the Office for National Statistics (ONS) on Wednesday provided a mixed message for policymakers.
Although unemployment increased modestly for the first time in two years, wage inflation picked up slightly.
UK unemployment for the three months to the end of December disappointed forecasts, edging up to 4.4% from 4.3%, which was a 42-year low.
Economists had expected the rate to remain unchanged for what would have been a sixth consecutive month.
Behind the headline figures was a 46,000 increase in the number of unemployed, with a 109,000 rise in the number of previously inactive people looking for work.
At the same time, the number of people actually in work increased by 88,000.
The latter suggests that currency markets could be reading too much into the headline figure.
“Don't be too alarmed by the rise in unemployment. It was driven by a surge in the workforce, not falling employment. High job vacancies and business surveys suggest employment will continue to rise at a healthy rate this year,” said Samuel Tombs, chief UK Economist at Pantheon Macroeconomics.
“Admittedly, this was below the consensus expectation for a larger 173,000 increase and a rise in the participation rate pushed the unemployment rate up from 4.3% to 4.4%,” said Ruth Gregory of Capital Economics.
Average weekly earnings in the three months to December excluding bonuses rose 2.5% year on year, versus 2.3% in the period to November. With bonuses included, the rate was unchanged at 2.5%.
While the data suggests UK wage growth has slightly improved, wage inflation remains well below consumer price inflation.
Official data released last week showed UK consumer price inflation remained unchanged from the prior month at 3% in January, confounding economists´ consensus expectations for a modest fall to 2.9%.
Nevertheless, the wage inflation data released on Wednesday suggests the gap is gradually closing.
“Pay growth seems to be starting to benefit from the recent strength of jobs growth at last,” added Gregory.
Overall, the flavour of Wednesday´s official UK data was broadly in line with the key messages from IHS Markit/REC Report on the jobs market earlier this month.
The survey pointed to a stronger rise in permanent placements in contrast with weaker growth on the temporary front.
It found overall growth of demand for staff had slightly moderated.
More importantly for the future path of sterling, the survey found that starting salary inflation had reached its highest level in 31-months owing to growing candidate shortages.
It is therefore the ongoing tightness of the UK labour market that likely explains the modest increase in wage inflation seen in Wednesday´s official data.
We could easily see more of this over the coming months.
So, where does all this leave UK interest rate policy?
Earlier this month, the minutes of the BoE´s Monetary Policy Committee meeting sent a more hawkish message to investors, despite the BOE leaving interest rates on hold at 0.5%.
Following the minutes, economists generally saw increased probability of a UK rate hike in May with the potential for an additional rate increase before the end of 2018.
Citing the generally positive global growth backdrop as well as the UK economy´s apparent reduced post-crisis ability to expand without sparking inflation, the BoE had warned that UK interest rates would likely need to be “tightened somewhat earlier and by a somewhat greater extent.”
Wednesday´s data should do little by itself to dissuade those already pricing in a May rate hike, though the mixed nature of the data certainly indicates that such a near-term increase is far from a forgone conclusion.
On the one hand, much of last year´s acceleration in UK inflation has been attributed to the significant post-Brexit vote depreciation in sterling of 2016.
The delayed nature of currency impacts on import prices means such events take time to work through to UK prices on the high street.
By the same token, as sterling has been relatively stable during 2017, and shown some signs of strength so far in 2018, inflationary pressures could easily abate over the coming months.
This though could be counteracted by a combination of higher oil prices and any further rise in wage inflation.
At 3%, inflation already remains well above the BoE´s 2% target.
Sterling is also likely to be prone to volatility due to ongoing Brexit uncertainties.
Year to date, sterling is up about 6% and 1% against the dollar and euro respectively.
Whether sterling can extend these gains is likely to depend to a great extent on the outcome of Brexit negotiations.
An amicable agreement with the EU and hence greater access to the EU´s single market post Brexit would likely put upward pressure on both UK interest rate expectations and the pound.