The traditional relationship between falling unemployment and faster inflation, known as the Phillips curve, has widely been considered just another victim of the last financial crisis. Due to the implementation of unorthodox monetary policies, namely QE, this longstanding relationship first highlighted in 1958 and widely accepted by the 1970’s was deemed outdated and unsuitable for analyzing modern day inflation dynamics.
The scars of the recession following the 2008 crisis may have made workers less able to bargain for higher pay. Competition from emerging markets reduced trade union power and technological advances also limited employees negotiating ability. Just this week, Federal Reserve (FED) Governor Lael Brainard said she did “not view the improvement in the labour market as a sufficient statistic for judging the outlook for inflation” and that the argument for the Phillips curve was “at best, very weak.”
This is of particular interest and significance lately as markets look to the FED and BoE for clues when both central banks will begin the process of raising interest rates. In the wake of the headline figure for non-farm payrolls (NFP) missing the expectation, little attention was drawn to the unemployment rate that in fact ticked lower. Granted the decrease was so small, that it didn’t show after rounding as the figure was announced at 5.1%, but this still shows downward pressure on a rate that was already at a 7-year low.
The picture is similar in the UK as this morning’s release also showed a 7-year low in the figure, as it moved down to 5.4%. These figures rarely grab the headlines as the NFP or claimant count change for the US and UK do respectively, but they both show sustained downward pressure on unemployment, which should lead to upward pressure on inflation if the theory that New Zealand born Economist William Phillips first suggested still holds.
Fed Chair Janet Yellen noted this in remarks made last month when she stated that “a labour market moving toward full employment is one that historically has generated upward pressure on inflation. So that bolsters my confidence in inflation.” This suggests perhaps both the FED and BoE are closer to liftoff than markets currently expect and potentially paves the way for a few Hawkish surprises in the coming months.
Please note this graph is just an illustration to demonstrate a traditional Phillips Curve. The figures and curve itself bear no relationship to any actual data.