US strong labour market triggers surge in costs

The ADP survey suggests that private sector employment increased by 217,000 in November which, assuming the official payrolls figures show a similar-sized increase this Friday, would be enough to seal a first interest rate hike at the Fed's mid-December FOMC meeting.

November's ADP gain represents a slight acceleration on the 196,000 increase in October. More generally, after a brief worry thanks to two underwhelming employment reports in August and September, the labour market appears to be holding up well.

As Atlanta Fed President Dennis Lockhart noted this morning, with the unemployment rate down to 5.0, the economy appears to be closing in on full employment. According to Lockhart, the case for a December rate hike is now "compelling". Of course, the markets will be more focused on Fed Chair Janet Yellen's lunch time speech to the Economic Club of Washington.

"We don't expect her to be quite as forthright, but we do anticipate some pretty clear signals that a rate hike is imminent. That said, there will also be a lot of stress on the Fed's plan to raise rates only very gradually after the first hike", says Capital Economics in a research note.

Whether the Fed will be able to stick to those plans next year is another matter, however. Domestic price pressures are really beginning to mount now. This morning it was also learned that unit labour costs increased by 1.8% annualised in the third quarter. More worryingly, over the past 12 months, unit labour costs are up by 3.0%.

 In a relatively closed service-based economy like the US, unit labour costs are the biggest input into production. The deflationary shocks from the slump in commodity prices and the stronger dollar are keeping inflation very low for now. But next year will be a completely different story.

"We anticipate that rising inflation will prompt the Fed to abandon its gradualist strategy, with the fed funds rate ending next year above 1.5%",added Capital Economics.