The labour market continued to move towards stabilisation over the summer, with the unemployment rate holding steady at 4.9%, the same level as in February when the conflict in Iran began. However, vacancies and payroll data paint a weaker picture. Meanwhile, rising input costs, persistent uncertainty and higher borrowing costs are likely to weigh on hiring, pushing the unemployment rate back above 5.0%. For the Monetary Policy Committee (MPC), a weak labour market should be enough to keep rates on hold this week. However, the recent rise in energy prices means inflation is now likely to peak around 4%, which means the risk of a rate hike before year-end has risen sharply.

Labour market stabilising

The labour market continued its gradual shift from deterioration to stabilisation over the summer. Employment rose by 66,000 in the three months to July, according to the Labour Force Survey (LFS), helping keep the unemployment rate at 4.9% for a fourth consecutive month. Taken together, this suggests the labour market has broadly stabilised so far this year, albeit at a relatively weak level.

However, the LFS continues to be distorted by a low response rate, so we must look at a broader range of indicators when assessing the labour market. By that measure, the picture appears weaker. Payrolls fell by 26,000 in August, while July's decline was revised worse from 13,000 to 19,000. Vacancies also fell by a further 4,000. Together, these indicators suggest the labour market is still gradually weakening despite the stable headline unemployment rate.

All told, the labour market appears to be edging towards stabilisation. However, rising input costs, tighter financing conditions and persistent uncertainty are likely to keep hiring subdued. As a result, we expect labour market conditions to weaken again in the second half of the year, pushing the unemployment rate back above 5% in the coming months.

MPC will take comfort from easing pay growth

The weaker labour market continues to weigh on wage growth. Private sector regular pay growth, the measure most relevant to the MPC because it better reflects underlying inflationary pressures, remained at 2.9%. That leaves pay growth below the Bank of England's estimate of 3.25% target-consistent wage growth.

For the MPC, subdued wage growth will probably be enough to justify leaving rates unchanged this week. Admittedly, business surveys suggest pay growth could edge higher in the coming months, which will keep policymakers cautious especially as inflation approaches 4% towards year-end. Nevertheless, we aren’t expecting a sharp acceleration in wage pressures as the weaker labour market should limit workers' ability to secure larger pay rises in response to higher inflation, unlike in 2022.

In any case, inflation is already running at 2.9% and looks set to rise further in the coming months as higher oil prices feed through to fuel costs and broader supply chains. That means a real terms pay cut for private sector workers looks like an odds-on bet in the second half of the year. In turn, that could drag on consumer spending and derail the strong economic growth the UK has seen so far this year.

Ultimately, the labour market has been gradually stabilising in recent months, but we think that trend will begin to reverse in the coming months as the Budget adds to already elevated uncertainty, surging input costs squeeze margins and higher financing rates all drag on hiring. While that weakness should strengthen the case for keeping rates on hold, it may not be enough to prevent further rate hikes if energy prices push inflation towards 4% and economic activity continues to outperform expectations.

Related insights