The UK labour market showed further signs of weakening across December and January. Falling payrolls, another rise in the unemployment rate and slowing private sector pay growth all point towards the Monetary Policy Committee (MPC) cutting interest rates again in March. Yet, surveys suggest private sector pay growth will stay around 3.5%. That’s above the level consistent with 2% inflation, which will limit the Bank of England’s (BoE) ability to cut rates further. Although the jobs market can turn quickly, there’s a risk more slack than we currently expect builds in the UK jobs market.

UK labour market loosened further

The official employment figures show the UK unemployment rate rose to 5.2%, above the BoE estimate of 5.1%. This despite employment rising by 52,000 in the three months to December, boosted by fewer people being inactive in the labour market.

That said, the Labour Force Survey (LFS) remains distorted by a low response rate, despite the Office for National Statistics’ (ONS) success at boosting the sample size. As a result, the BoE will need to focus on a broader set of indicators.

Indeed, there was more evidence of weakness here, too. HMRC data shows payrolls fell by 11,000 in January. However, there were also nascent signs of stabilisation. January’s fall was the smallest first estimate since September and December’s 43,000 drop was revised up to just 6,000.

Vacancies have been broadly stable for around 8 months now, with January’s drop reversing December’s rise. Redundancies also held steady in December and are well-contained. Both imply hiring is stabilising after a period of weakness following the big increase in employment costs last year.

Overall, the data suggests the labour market was still weak at the end of last year. However, there are signs it could stabilise soon. Rebounding growth in Q1, easing policy uncertainty and no big increases in employment costs should all support the jobs market in 2026.

UK pay growth likely to keep inflation elevated

Turning to pay growth, private sector regular pay growth – the measure relevant to the MPC because it reflects underlying inflationary pressures most – eased in December to 3.4% from 3.6%. This matched the BoE’s forecast and is still a little above the 3.25% level the BoE estimates to be consistent with inflation stabilising at 2%.

Furthermore, whole economy pay growth is still above 4%. That’s because public sector pay rises have come in earlier than usual. More importantly to the MPC, pay growth surveys have levelled out. This means private sector pay growth is unlikely to fall much further. Indeed, the single-month measure of private sector pay growth rose in December for the first time in over a year.

In any case, the Minutes from February’s MPC meeting clearly signalled a dovish turn. The majority of the Committee showed they were more concerned about a cooling labour market and weak demand than they were about heightened inflation expectations and sticky pay growth. As a result, we expect the MPC to focus on the surprise rise in the unemployment rate and still-weak payrolls.

All told, the labour market continued to loosen at the end of last year and more timely indicators suggest this continued into the new year. Today’s data is likely to seal the deal on a March rate cut and furthers the case for another in the summer. However, the BoE will still have to be cautious amid sticky pay growth and therefore domestically generated inflation, especially as interest rates creep closer to neutral. All told, we think interest rates will end the year at around 3.25%.

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