The labour market continued stabilising across June and July with unemployment holding steady and payrolls barely falling. However, the labour market is likely to weaken further in the coming months as the impact of surging input costs due to the war in Iran work through supply chains and uncertainty makes firms more reluctant to hire. For the Monetary Policy Committee (MPC), subdued wage growth and a renewed rise in unemployment in the second half of the year should support keeping rates on hold for the rest of 2026, before resuming rate cuts in 2027.

Labour market stabilising

The labour market moved from deterioration towards stabilisation in June. Employment on the Labour Force Survey (LFS) measure rose by 84,000 in the three months to June, helping the unemployment rate remain at 4.9% for a third consecutive month. However, the LFS should be treated with even more caution than usual because a further survey issue reduced the number of responses collected.

Indeed, payrolls fell by just 13,000 in July, matching the decline in June. Given the predictable pattern of revisions much of that fall is likely to be revised away in future data releases suggesting that the labour market is weakening only gradually. Vacancies also fell by just 1,000 over the latest quarter, so any rise in the unemployment rate over the second half of the year should be relatively contained.

Even so, the bigger picture is that we expect the labour market to weaken further in H2. Vacancies have fallen by 27,000 so far in 2026, which should feed through to weaker employment growth in the coming months, and we expect the unemployment rate likely rose in July. Further ahead, we expect the unemployment rate to peak at around 5.3% later this year as higher input costs, tighter financing conditions and persistent uncertainty curb firms’ appetite to hire.

MPC will take comfort from easing pay growth

Slack in the labour market continues to weigh on pay growth. Private sector regular pay growth, the measure most relevant to the MPC because it better reflects underlying inflationary pressures, eased from 2.9% to 2.8%. That puts private sector pay firmly below the Bank’s 3.25% estimate of target-consistent pay growth, which will reassure the Committee that domestically generated inflation is trending in the right direction.

Granted, the MPC will remain cautious. Whole economy pay growth including bonuses is stickier, at 4.1% and surveys suggest that private sector pay growth is likely to rebound a little in the coming months.

Even if pay growth picks up slightly, households are unlikely to feel much relief. Inflation should peak around 3.5% this year, leaving real wages broadly stagnate in the latter half of the year. That will only increase the pressure on the new government to act on the cost of living at the Budget and probably prompt the solid growth in consumer spending seen in the first half of the year to fade.

For the MPC, the data provided a slightly dovish tilt with pay growth matching the MPC’s forecast and unemployment coming in 0.1ppt higher. Today’s data, alongside further weakening through the second half of the year as higher energy prices bite, will strengthen the case for the Committee to remain on hold throughout the second half of the year.

Ultimately, the labour market was stabilising through the first half of 2026 despite the war in Iran and a new government raising uncertainty. Further ahead, we expect the labour market to weaken further, with the unemployment rate moving back over 5.0%, as the impact of surging input costs continues to work through supply chains, demand eases back and continued uncertainty weighs on hiring.

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