Labour market cooling, but won’t prompt BoE to cut rates quicker

A rising unemployment rate, falling payrolls and slowing wage growth reflect a cooling labour market. What’s more, payrolls data paints a stark picture for private sector employment, suggesting it has actually shrunk since January 2023. However, despite a clear weakening, private sector pay growth is still running at almost double the rate the Monetary Policy Committee (MPC) thinks is consistent with 2% inflation. We therefore doubt the MPC will be tempted by a cut in June, but slowing wage growth will allow it to cut two more times this year.

Fewer private sector jobs than two years ago

The headline measure of employment rose by 112,000 in the three months to March, but that didn’t stop the unemployment rate ticking up to 4.5%. Part of this was due to a rising population, which grew by 147,000 in the first quarter. More important for policymakers was the 54,000 fall in inactivity over the last three months.

That said, the Labour Force Survey (LFS) from which the headline numbers are produced is somewhat untrustworthy thanks to a collapse in the response rate since Covid-19 and despite attempts to reform the survey in the first quarter of this year. It means we must rely on a broader range of indicators to understand what’s happening in the labour market, all of which have their own drawbacks. For example, HMRC payrolls only include people paid through PAYE and therefore would miss most self-employed workers.

The number of people on HMRC payrolls did show another decline of 33,000 in April, while March’s figure was revised up, but still showed a reduction of 47,000. Normally, we would expect payrolls data and official employment figures to move together. However, issues with the LFS and the changes in tax introduced in the Autumn Budget encouraging self-employment mean the measures have diverged recently.

This means that since the Autumn Budget in October, payrolls have fallen by 150,000 as firms prepared for April’s increase in employment costs. Unsurprisingly, low-paid industries, those hit hardest by the higher employer costs, such as retail and hospitality, made up 69% of the fall over that period.

Payrolls data now suggests that private sector employment is 0.2% smaller than it was at the start of 2023. Indeed, all the growth in payrolls over that period has come from the public sector. A proxy indicator comprising employment in health, education and public administration has grown 5.2% over the same period.

Clearly, the labour market has cooled over the last six months, but we are yet to see any evidence of the collapse in employment that survey data has been suggesting since the Autumn Budget.

Labour market loosening to prompt quicker pay growth falls

Labour demand has eased sharply in recent months. Vacancies are now 4.3% lower than pre-pandemic levels in the first quarter of 2020. The unemployment-to-vacancy ratio – a measure of labour market tightness showing how many unemployed people there are for available jobs – ticked up to 2.1 in the first three months of 2025, up from 1.9 in the final quarter of 2024. That will provide some comfort to the MPC: a greater margin of slack should mean wage growth starts to slow, which would allow the Bank of England (BoE) to continue to cut interest rates without risking a rise in inflation.

Indeed, average earnings growth fell to 5.5% from 5.7% in March. More importantly, private sector pay (excluding bonuses) growth, which is the most representative measure of domestic inflation pressures in the economy, fell to 5.6% from 5.9%.

However, that is still far too high for the BoE to relax. In fact, Deputy Governor of the BoE, Clare Lombardelli, said in a speech this week that “my focus is on wages, as they are the largest component of the prices set by domestic services firms, and so a key driver of moves in underlying inflation” before emphasising that “wage growth around 3% and potentially a bit higher would be consistent with inflation at target”.

The BoE will be reassured that underlying pay growth has eased considerably in the last few months. On a 3m/3m annualised basis private sector (excluding bonuses) pay growth, a measure that shows underlying pay growth pressures and provides a sign on where pay growth may be heading, fell to 3.4% from 4.3% last month. For comparison, in December that measure of underlying pay growth was still 6.2%. This rapid cooling should feed through into the headline numbers throughout the rest of this year. However, the punchy increases in the National Living and National Minimum Wages risk pushing April’s headline numbers back up and slow the easing in wage growth that we expect.

MPC won’t be tempted to cut faster despite cooling labour market

Overall, the labour market is clearly loosening. Unemployment has ticked up and the fall in labour demand suggests the economy is starting to slow in the face of higher employment costs and tariffs.

Despite the slowdown in wages, more hawkish MPC members will still be far too concerned about strong wage growth to even contemplate cutting rates again in June, despite calls from other members to speed up the pace of easing.

Further ahead, wage growth should continue to slow as the looser labour market and higher taxes bears down on it. However, wage growth has been far stickier than policymakers had anticipated. Hawkish members of the MPC will be resistant to a faster pace of cuts and will want to wait until there’s clear evidence that wage growth has substantially weakened.

The clear risks here are that the labour market data is too backwards looking, Trump’s tariffs make March feel like a long time ago now and that the sustained collapse in survey data does indeed turn out to be correct. In this scenario, the MPC will have to cut further and faster than we currently assume.

On balance, we think the MPC will walk a narrow path between cutting interest rates to support the economy, while ensuring that the disinflation process remains intact. Ultimately, we still expect two more cuts this year, which would leave interest rates at 3.75% by the end of Q4.

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