By Olesya Dmitracova and William Schomberg
LONDON, Sept 11 (Reuters) - Britain's unemployment rate dropped in July to its lowest since late last year, prompting further market speculation that the Bank of England may raise interest rates earlier than it has indicated.
The rate dipped to 7.7 percent in the three months ending in July, the Office for National Statistics said on Wednesday. That was its lowest since September-November 2012 and confounded most forecasts for an unchanged reading of 7.8 percent.
To support Britain's burgeoning economic revival, the central bank says it will not consider raising rates before unemployment falls to 7 percent, something it does not think will happen before the third quarter of 2016.
Markets, however, are betting on a much faster decline, reacting sharply to anything they see as evidence to back their case.
The pound jumped to a multi-month peak against the dollar and British government borrowing costs rose, with the premium over German bond yields back at its highest level in three years. Gilt prices recovered later, suggesting much of the good economic news is already priced into the market.
British Prime Minister David Cameron welcomed the fall in unemployment. Two days earlier, his finance minister, George Osborne, said the country's economy was turning a corner after struggling to recover from the financial crisis.
'It's another set of impressive figures,' said Investec economist Victoria Clarke. 'It suggests the jobs market is recovering much like the broader economy. It reinforces our view that unemployment will come down to 7 percent more quickly than the Bank of England expects.'
All but a handful of economists taking part in a Reuters poll agreed, saying the unemployment rate would reach the 7 percent threshold before the third quarter of 2016. The poll was conducted before Wednesday's unemployment numbers.
Investors have priced in the first rise in interest rates around late 2014 or early 2015. Such bets have led to rises in a range of market interest rates, including those that usually feed through to mortgages and other loans.
This risks a future confrontation between the Bank of England and financial markets. BoE Governor Mark Carney has warned that the bank might provide more stimulus for the economy if Britain's recovery is threatened.
The Bank believes the jobless rate will fall sharply in 2014 before easing more gently over the following two years as firms squeeze more out of current staff. Surveys of British services and manufacturing last month backed up that view as employment grew more slowly than overall activity.
But in another sign of surprising strength in Britain's labour market from Wednesday's data, the number of people claiming jobless benefit - a narrower and timelier measure of unemployment - fell by a bigger-than-expected 32,600 in August.
July's fall was also revised to show a drop of 36,300 - the steepest decline since June 1997.
Graphic on UK labour market on the mend:
PAY FALLS FURTHER BEHIND
Not all analysts think that the latest sign of improvement in the labour market heralds earlier monetary tightening.
'Although employment rose strongly, more timely evidence from the recent activity surveys suggests that firms are responding to higher demand more by boosting productivity than taking on new workers,' said Martin Beck, economist at Capital Economics.
Forecasting the path of Britain's unemployment has been complicated in recent years by older workers rejoining or remaining in the labour force, uncertainty about immigration levels and job cuts in the public sector.
The ONS said on Wednesday that public-sector employment fell in the second quarter by 34,000 to 5.665 million.
The data also showed a record number of people working part-time because they could not find a full-time position - another potential brake on future growth in the number of workers.
Stronger productivity is unlikely to boost real wages anytime soon: average weekly earnings growth including bonuses slowed to 1.1 percent in the three months to July compared with a year earlier. Excluding bonuses, pay grew 1.0 percent.
By contrast, inflation averaged 2.8 percent over the same period. Britain's Labour party says falling living standards undermine the government's claims that its austerity drive helped the economy by keeping borrowing costs down.
On Wednesday, British supermarket chain ASDA warned of five more years of hardship for many families. It published a report saying households will be 1,300 pounds ($2,000) a year worse off in real terms in 2018 compared with 2009 due to rising costs, stagnating pay and austerity measures.
($1 = 0.6361 British pounds)
(Additional reporting by Christina Fincher; Editing by Jeremy Gaunt) Keywords: BRITAIN LABOUR/
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