The labour market looked to be improving in April and May, with unemployment falling and payrolls rising. However, the labour market is likely to weaken further in the coming months as vacancies continued to fall in response to higher energy prices squeezing margins and hence weighing on hiring. For the Monetary Policy Committee (MPC), a stronger than expected labour market report raises the likelihood of rate hikes at the margin. However, we think the MPC will focus on lower energy prices, target consistent pay growth and an impending rebound in the unemployment rate, prompting them to stay on hold this year before resuming cuts in 2027.

Hawkish employment data, but won’t last

The labour market was holding up during the first few months of the Iran war. Employment on the Labour Force Survey (LFS) measure, which is still distorted by a low response rate, grew by 100,000 in the three months to April, which helped the unemployment rate to tick down to 4.9%, the lowest since August 2025. That said, some of the drop in the unemployment rate was driven by people leaving the labour force, with inactivity rising by 33,000 on the month.

In any case, the number of employees on payrolls rose by 2,000 in May, the first rise in four months. What’s more, half of April’s shocking 100,000 fall was revised away and will likely still be revised better in the coming months. In short, the labour market looked to be stabilising across April and May, albeit at a weak level.

That said, we doubt the good news on the jobs market will last for long. Vacancies fell by another 2,000 and are now at the lowest level since April 2021, as surging uncertainty due to the conflict in the Middle East. Meanwhile, the increasing likelihood of a new government that opts for another round of tax hikes prompts firms to hold off on hiring plans. Indeed, the fall in vacancies suggests that the unemployment rate will reassert its upwards trend in the coming months, as our chart below shows.

Further ahead, even with a peace accord that has seen energy prices fall back sharply, firms will still face a wave of rising input costs coming through supply chains for the rest of the year. At the same time, the hit to real household disposable incomes means GDP growth will slow sharply from Q1s punchy 0.6% across the rest of this year, pushing the unemployment rate to a peak of 5.3%.

Pay growth consistent with inflation at 2.0%

The weaker labour market continues to weigh on pay growth, with private sector pay growth excluding bonuses, the measure most relevant to the MPC as it’s more reflective of underlying inflationary pressure, easing to 2.9% from 3.1%. Private sector pay has now been at or below the 3.25% level that the Bank of England (BoE) estimates is consistent with 2% inflation for three months. This will reassure the MPC that the labour market is already weak enough to bring domestically generated inflation to heel.

Admittedly, the MPC will still have to be cautious, whole economy pay growth including bonuses, which is a better measure of household’s ability to spend, is running at 4.4% in April and is likely to nudge up in May. In fact, private sector pay excluding bonuses, is now running well below the steer from private sector surveys and alternative data sources, suggesting the official pay data will rebound back towards 3.25-3.5% later this year.

Even if pay growth rebounds, the labour market is much weaker than it was in 2022 which means that pay growth is unlikely to surge as it did following the Russian invasion of Ukraine when workers were able to bid up nominal wages in response to higher inflation. Given that we expect inflation to peak at around 3.5% later this year, that means real incomes are set to stagnate during the second half of the year which will drag on consumer spending. This is the key reason why we expect GDP growth to average just 0.1% per quarter for the rest of the year.

For the MPC, today’s solid employment data might raise the likelihood of rate hikes at the margin, but we doubt it will tilt most of the MPC towards hikes. The doves will point to target-consistent pay growth to argue that rates can stay on hold while still weighing on inflationary pressures. Further ahead, the labour market is likely to weaken further in the coming months as real incomes and margins are squeezed, prompting firms to cut back on hiring in response. This will only boost the argument for staying on hold. That said, signs of resilient employment in today’s data, modestly de-anchored inflation expectations and another year of above target inflation will mean there’s no return to rate cuts until 2027.

Ultimately, the labour market was holding up through the first few months of the Iran war, which might encourage the hawks on the Committee to push for rate hikes. However, energy prices have fallen back sharply, and the labour market is likely to weaken further in the coming months which will ensure the MPC stay on hold this year to avoid pushing up unemployment further.

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