The labour market remained weak in March and April with the unemployment rate rising, payrolls collapsing and vacancies ticking down. Looking ahead, the unemployment rate will continue trending up as higher inflation squeezes margins and in turn weighs on hiring. For the Monetary Policy Committee (MPC) this will assure members that the jobs market is too weak to lead to significant second-round effects which will allow it to remain on hold this year, unless energy prices go much higher.

Unemployment rate to keep climbing

The labour market was stabilising, albeit at a weak level, in the first month of the Iran war. Starting with the official employment data, employment growth of 148,000 in the three months to March, the strongest figure since July 2025, suggested that jobs growth was holding up in the first month of the conflict. That said, this wasn’t enough to prevent the unemployment rate from rebounding to 5.0%, above the MPC’s forecast of 4.9% as some of February’s huge surge in inactivity unwound. Admittedly, despite the ONS increasing the sample size of the LFS, a low response rate continues to distort the survey. In any case, we expect the unemployment rate will continue its upwards trajectory over the coming months as higher inflation and slower growth squeeze margins and in turn dampen employment growth.

Indeed, the early data for April show the number of people on payrolls collapsed by 100,000. Granted, big falls in payrolls are reliably revised away, especially at the start of the tax year, but even after the usual upwards revisions the figures will continue to show declining employment. What’s more, vacancies have dropped to the lowest level in five years, when the pandemic was still disrupting hiring, together with payrolls this suggests that firms may have already put the brakes on hiring in response to uncertainty over the Iran war and another hike to the national living wage.

Looking ahead, the risk is clearly that higher energy prices will push up input costs for firms, while the hit to real household incomes means consumers will simultaneously pull back on spending. This will prompt firms to cut back on hiring, which is why we now expect the unemployment rate to peak around 5.5% this year, despite signs that the labour market was levelling out at the start of the year.

Wage growth to mean MPC focuses on weak growth

The weak labour market continues to weigh on pay growth, private sector pay excluding bonuses, which is the measure most relevant to the MPC as it is more reflective of underlying inflationary pressures, dropped to 3.0% from 3.2%. This is below the 3.25% that the MPC estimates is consistent with inflation stabilising at 2.0%.

Taken together with falling vacancies and a rising unemployment rate, this supports our view that workers are in a much weaker position than they were in 2022 when the jobs market was tighter. This means that employees will struggle to bid up nominal wage to protect their real incomes from higher inflation. This has two big impacts on the outlook this year. First, weaker real income growth means that growth will probably be less resilient than it was 2022. Second, the reduced risk of second-round effects from workers bidding up wages will prevent inflation from running away and allow the Bank of England to avoid an aggressive hiking cycle. In simple terms, we think relatively more of the impact will fall on activity than inflation compared to in 2022 which is why our base case is for the MPC to stay on hold this year, unless energy prices surge further which would push inflation up significantly higher.

Admittedly, we think private sector wage growth will rebound slightly in the second half of this year. Private sector pay is now undershooting the steer from almost every survey and wage settlements for 2026 will largely have been agreed before the Iran war. A rebound to 3.25-3.5% by the end of this year seems likely, but this is a far cry from the Russia-Ukraine crisis when pay growth peaked at over 8.0%.

Ultimately, the labour market was stabilising at the start of the year before the conflict in Iran disrupted the outlook. That said, Q1 was a long time ago, we expect the labour market to weaken over the rest of this year as higher energy prices cascade through the UK economy. This will keep the key swing voters on the MPC cautious about hiking rates despite another period of elevated inflation this year, but the risks are clearly skewed towards a short and shallow hiking cycle.

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