Unemployment and Exchange Rate

Readers Question. Lastly, what effect would a poor unemployment figure (e.g. lower than expected nonfarm payroll numbers) have on a country’s currency? Is it likely to strengthen (due to lower expectations of inflation) or weaken (due to less domestic productivity and higher imports?

Poor unemployment figures would probably weaken the currency.

If unemployment figures are worse than expected, the Central Bank is likely to delay increasing interest rates. If unemployment rises very sharply they may consider cutting interest rates or even pursue quantitative easing.

For example, some analysts had expected an increase in UK interest rates this summer, but a succession of poor economic data has pushed this back to later in year. You don’t want to increase interest rates when unemployment is rising.

Impact on Exchange Rate

Interest rates are a key determinant of short-term exchange rate movements. If interest rates in UK are relatively higher than other countries, it will make it more attractive for investors to save money in the UK. This will cause ‘hot money flows’ into the UK, increasing demand for sterling and increasing the value of the exchange rate.

Thus unemployment figures which reduce chance of increasing interest rates will make the currency less attractive.

Long Term Factors

In the long term,  a country may boost productivity and competitiveness, this would create jobs and increase demand for exports. This would also help reduce unemployment and strengthen the exchange rate.

High unemployment may be caused by a lack of competitiveness which reduces the value of the exchange rate over time.

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One Response to Unemployment and Exchange Rate

  1. debt recovery agencies uk June 15, 2011 at 10:21 am #

    Unemployment is a severe issue and it need to be solved anyway to get rid off the interests and investment quotients or as a whole the banking systems. Inflation rate is also dependent on it as the whole economical structure of a society is based on the employment issues. Very efficient post by the author and also seems well-researched one. Thanks for sharing with us.