Pound rallies vs dollar as data suggests BoE has room to hike

By Lucy Raitano

LONDON - Sterling strengthened against a broadly struggling dollar but fell against a firmer euro on Tuesday, with domestic politics still in the spotlight and the latest data suggesting the cost-of-living squeeze had not yet hit demand for staff in Britain.

Data showed Britain's unemployment rate holding at 3.8% in the three months to May while the number of people in work rose by the most since the middle of 2021.

"The labour market data this week was once again strong and this will allow the BoE to tighten more aggressively without fear of damaging employment levels," said Stuart Cole, head macro economist at Equiti Capital.

Sterling was last up 0.7% at $1.20340, but down 0.3% against the euro at 85.14 pence.

The drop against the euro came as the single currency benefited broadly from a source-based report that the European Central Bank would discuss whether to raise interest rates by 25 or 50 points at their meeting on Thursday.

Politics also remained in focus for sterling traders as the contest to replace Boris Johnson as British prime minister continues to narrow.

Former finance minister Rishi Sunak won the fourth round of voting but his two remaining rivals, Foreign Secretary Liz Truss and Penny Mordaunt, a junior trade minister, were closing the gap.

Views on what the contest means for sterling's outlook were mixed.

With diverging approaches to fiscal policy, whoever becomes the next prime minister could affect the trajectory of future fiscal policy, although a top central bank official pushed back against this.

"Her (Mordaunt's) win would actually represent a shift in the respect of tighter fiscal policy, which is going to allow the economy to grow in a more sustainable manner," said Vasileios Gkionakis, EMEA Head of CitiFX G10 Strategy, adding that Sunak represents a continuation of the status quo.

The Bank of England is struggling against soaring inflation and a cost-of-living crisis, having raised interest rates five times since December as it has tried to halt a surge in inflation from becoming embedded in the economy.

Sunak is the markets' preferred candidate, said Equiti Capital's Cole.

"He is seen as the most astute and economically competent person to run the country," said Cole.

"Cutting taxes etc, may be pleasing to voters, but the markets, I would expect to be far more tepid in their response and will shun sterling accordingly."

(Reporting by Lucy Raitano; Editing by Bradley Perrett and Alison Williams)