The U.S. labour market remains strong, according to incoming data. Image © Adobe Images.

The Pound to Dollar exchange rate (GBP/USD) is under pressure amidst signs the Federal Reserve might have to raise interest rates to 5.4% amidst ongoing strength in the U.S. labour market.

The Federal Reserve's minutes for the December meeting were released overnight and revealed policymakers were not ready to entertain an interest rate cut later in 2023, which pushed back against the more 'dovish' expectations in the market that the emerging U.S. economic slowdown would allow the Fed to begin easing policy.

Instead, policymakers said they prefer to remain vigilant and would rather 'overtighten' rates than risk letting inflation run away by easing monetary policy prematurely.

Higher-for-long rates at the Fed would be, on balance, supportive of the Dollar; as are comments by a key member of the Federal Reserve Open Market Committee (FOMC).

"The Fed minutes offered a tinge of hawkishness with concern over a loosening of financial conditions," says a daily currency research note from TD Securities. "It is at a minimum consistent with the idea that it may be difficult to push USD weakness in the near-term."

FOMC voter Neel Kashkari spoke on Wednesday and said he backs a peak in Fed interest rates at 5.4% which suggests interest rates might rise higher than many in the market are anticipating.

Emerging support for the Dollar capped a rally in GBP/USD at 1.2088 and brings it back down to 1.2020 at the time of writing Thursday.

Incoming data is meanwhile consistent with the need for the Fed to remain vigilant with above-forecast prints for U.S. ISM employment index and JOLTs job openings confirming the labour market remains tight enough for the Fed to maintain a focus on higher rates.

ISM's Employment Index returned to expansion territory (51.4%, up 3 percentage points) after contracting in November (48.4%). The U.S. Bureau of Labor Statistics meanwhile said the number of job openings was little changed at 10.5 million on the last business day of November, defying expectations for a retreat to 10m.

"In short, the labour market is still not showing any sign of cooling after 425bp of tightening according to the first anecdotes for December," says Kenneth Broux, an analyst at Société Générale.

The Fed will want to see the labour market deteriorate before considering a retreat from its policy of raising interest rates, this is because the healthy labour market is consistent with rising wages which is in turn an inflationary force.

"Confirmation is likely to follow today in stable and low jobless claims and will make investors apprehensive about trying to force long end yields beyond the next support levels before NFP tomorrow," adds Broux.

GBP/USD and other Dollar exchange rates will continue to churn around current levels ahead of Friday's non-farm payrolls report, which is considered to be the definitive U.S. labour market report.

Any unexpected deterioration in the data would suggest perhaps the impact of recent interest rate hikes is starting to have an impact, which could reverse some of this week's Dollar-supportive developments.

"A day of consolidation with a firmer bias is on the cards before investors weigh up the latest average earnings data point tomorrow and whether it makes the Fed more or less likely to slow the pace from 50bp to 25bp in February," says Broux.

Should the payroll data come in stronger than expected then the Dollar would likely find further support.

The risk for those buying dollars is that the data trigger a more sustained trend in USD appreciation that pressures GBP/USD firmly below 1.20.

At the time of writing, we see spot at 1.2020, typical bank transfer rates at around 1.1775, competitive cash and holiday money providers quoting around 1.1907 and competitive transfer providers are now quoting in the region of 1.1979.