What a surprising June US jobs report could mean for central banks’ inflation measures

By the OFX team | 10 July 2023 | 4 minute read

A sharp selloff in equities, globally, has markets fearing that the ideal scenario of a ‘soft landing’ – slowed economic growth while avoiding recession – is increasingly unlikely and that much tougher measures could be required to bring inflation under control.

Much stronger than expected US jobs data for June, released on July 5, showed private sector jobs shot up by 497,000 for the month, much higher than the 220,000 jobs that had been forecasted. At nearly half a million new jobs created, that is the largest monthly rise since July 2022¹.

According to the data, wage rates are down a touch but still growing at 6.4%². At that level, it will definitely be a key inflationary concern for the US Federal Reserve.

The largest drivers of hiring were the hospitality and leisure sectors, not the sort of industries that should be putting on people given 10 interest rate rises in 15 months.

The US dollar shot up to its highest level in almost a month, against a basket of currencies, on the expectation that rates would have to increase further to dampen the economy.

This spike in US dollar value is because when rates rise in one country, investors chase the relatively higher returns there, pushing up demand for that country’s currency.

A day later, official non-farm payrolls showed something different, only 209,000 new jobs in June, the smallest increase in more than two and a half years³. That cooled nerves a bit, but it revealed salaries are still on the rise, up 4.4% over the past year. It was a clear sign that inflationary pressures are still a problem.

Members of the Federal Reserve are clearly worried about continued strong job growth. Despite leaving interest rates on hold in June, minutes from that meeting, released on July 5, showed that 16 of the 18 officials still expected rates would need to rise at least another quarter of a percentage point by the end of the year.⁴ These latest job figures make that expectation a near certainty, especially given inflation has been stuck around 4.6% since December.

The question is how much more inflation-busting rate rises are needed if the economy continues to show strength. 

Federal Reserve Chairman, Jerome Powell, and European Central Bank (ECB) President, Christine Lagarde, spent the last week of June at the ECB’s annual Forum on Central Banking at the former summer palace of the Portuguese royal family in Sintra, Portugal.

“It’s been surprising that inflation has been this persistent,” said Powell. “We have to be as persistent as inflation is persistent,” echoed Lagarde.⁵

The ECB is struggling with stubborn inflation too. Prices ticked higher in June to 5.4%, driven primarily by Germany. The good news was prices in France, Italy and the Netherlands all declined slightly, while energy costs (not included in core inflation figures) fell sharply.

“We have made our future policy decisions conditional on, first, the inflation outlook, second, the dynamics of underlying inflation and third, the strength of policy transmission,” President Lagarde told the annual ECB retreat. “Barring a material change to the outlook, we will continue to increase rates in July.”⁶

That means the ECB will be lifting interest rates even as the eurozone bumps along in a zero-growth environment, with retail sales and manufacturing growth turning downward in April and May. The services sector is also down, with confidence falling below the long-term average.⁷

The UK is not immune from further rate hikes either. After Bank of England Governor, Andrew Bailey, warned that inflation is still “far too high”, bond price movements suggested UK interest rates could go as high as 6.5% — the highest level since the Global Financial Crisis.⁸ 

What it means for currencies

With the US Federal Reserve, European Central Bank and Bank of England all expected to make further interest rates hikes, finding a clear view of how currencies will move, is getting harder. The pound is already up 5.4% on the US dollar year-to-date and 3.5% against the euro.

If interest rates go to the level that bond investors believe they will, then that appreciation trend should continue.

For the US dollar and euro, they could remain within a range-bound market, for a while. Both these currencies have one or two interest rate rises to come, but the one to watch will be the US Federal Reserve.

If further interest rate rises can’t get the economy to slow down, then it’s likely there will be more hikes in the future, pushing the USD higher.

The next big thing to look out for is the impact of ratcheting rates higher in the face of a slow-to-react economy. If the screws are turned too tight, that could cause some serious pain down the track.

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