(This Bloomberg story was updated by SIA with new information about UK inflation data)

UK unemployment fell unexpectedly after companies hired at the strongest pace since November, a sign of underlying strength in the economy that complicates the Bank of England’s shift toward lower interest rates.

In addition to yesterday’s positive employment news, this morning, the Office for National Statistics (ONS) published the latest inflation figures for July showing an increase of 2.2%, slightly smaller than the increase anticipated by the Bank of England, SIA reported. Core inflation (excluding food, energy, alcohol and tobacco) rose by 3.3% in the year to July, down from 3.5% in June. Inflation in the services sector, fell from 5.7% to 5.2% last month, SIA reported.

The jobless rate fell 0.2 percentage point to 4.2% in the three months to June, the ONS said Tuesday. Economists had expected a small increase. Employment surged by 97,000, much stronger than the 3,000 increase that forecasters had expected. Wage growth slowed in line with expectations, Bloomberg reported.

While economists questioned the reliability of the ONS’s Labour Force Survey, which underpins the unemployment data, investors interpreted the figures as a potentially inflationary sign the economy is picking up momentum. While the BOE has signaled it’s ready to cut borrowing costs again, it remains on guard against evidence that upward pressures on prices will stick around.

The headline unemployment rate is below the BOE’s forecast for 4.4% in the second quarter. Against the US dollar, the pound jumped 0.3% to trade above $1.28 on Tuesday, making the UK the best performing currency in the Group of 10 nations. It contrasts with the situation in the US, where weak jobs data rattled markets in recent weeks. Figures due later this week are likely to show robust economic growth in the UK and the first increase in inflation this year.

“Investors may raise questions about a weak US labor market and anemic euro area GDP growth, but the UK seemingly faces neither problem,” said Andrzej Szczepaniak, a senior economist at Nomura. “Still strong labor market data in the UK as well as still strong activity data support our house view of divergence between the Fed and BOE.”

Employment rose across the board, with only 16 to 17-year-olds registering a material decline over the quarter. The number of employees on company payrolls rose more than 24,000 in July, more than double the increase economists had forecast, according to real-time data derived from administrative data.

Prime Minister Keir Starmer’s government is eager to get more people back to work after more than 800,000 dropped out of the labor market during the pandemic. That worker shortage has held back the economy’s ability to expand without sparking inflation. Chancellor of the Exchequer Rachel Reeves embraced the figures but said further measures to encourage work will be in the budget.

“Today’s figures show there is more to do in supporting people into employment because if you can work, you should work,” Reeves said.

The Conservatives, who lost power in the election on July 4, said Tuesday’s data showed the previous government was delivering stronger growth. “Labour’s claims of a terrible economic inheritance are a complete fabrication,” said Mel Stride, the Conservative member of Parliament who speaks on work and pensions issues.

Separate data showed regular wage growth cooled to 5.4%, down from 5.8% in the previous period. It was the weakest year-on-year pay increase since the summer of 2022. Total pay growth, which includes bonuses, dropped sharply to 4.5%, down from 5.7%. This was largely driven by a one-time bonus paid to National Health Service staff last year.

BOE officials had been focused on the wage figures for signs of inflation but also are looking at the ability of the broader jobs market to drive up pay and prices.

A raft of UK economic data this week will set the tone for the BOE in the leadup to its next policy decision on 19 September. 

Following the release of the ONS inflation figures, City investors raised their bets that the Bank would cut interest rates in September. Money markets now indicate that there is a 45% chance that the Bank Rate will be cut to 4.75% next month from its current level of 5%, SIA reported. 

Some officials have signaled their lingering concerns over strong wage growth. Catherine Mann — who was among four hawkish rate-setters to oppose a change earlier this month — warned on Monday that an “upward ratchet” in wages and prices will “take a long time to erode away.”

“If you look more closely, the fall has been driven by public sector pay rather than private pay, which is the one the BOE is likely most worried about,” said Evelyne Gomez-Liechti, a strategist at Mizuho. “Mann already warned yesterday that the ‘upward ratchet’ in wages and priced will take ‘a long time to erode away’. It sounds like today’s data is unlikely to change her vote.”

There were some signs of a loosening labor market in the vacancies data with job openings edging down to 884,000. It was the lowest since mid-2021. The report also showed:

Regular private sector pay growth — which is being watched closely by the BOE for signs of domestic pressures — cooled to 5.2%, down from 5.6%. It was the lowest in over two years.

The employment rate edged up to 74.5%, the highest since the first quarter.

About 100,000 working days were lost to industrial action in June, due to strikes in the healthcare sector. That’s up from 51,000 in May.

Household finances continued to be bolstered by pay rises outstripping inflation. Real wage growth remained at 3.2%, the highest since 2021.

BOE officials have also been wary over interpreting the jobs data after the ONS temporarily suspended its Labour Force Survey last year. It is in the process of overhauling the survey but the introduction of new “transformed” figures has been delayed until next year.

The central bank expects unemployment to hit 4.8% in the coming years, remaining below the peaks seen in the pandemic and financial crisis.

“Despite the decline in the unemployment rate, we doubt today’s release will move the needle too much for the Bank of England,” said Ruth Gregory, deputy chief UK economist at Capital Economics. She said it is “difficult to know how much weight we should place on these figures” due to concerns over the accuracy of the data.

(SIA contributed reporting to this Bloomberg story. Bloomberg contributors included Greg Ritchie, Eleanor Thornber, Andrew Atkinson, Mark Evans and Joel Rinneby.)