The UK labour market remained soft in the first two months of 2026. The unemployment rate held at a five-year high and pay growth eased further than expected in January, although rising payrolls in February offered a hint of resilience. However, for the Monetary Policy Committee (MPC), this latest round of UK employment data matters less now because the Iran crisis has pushed its focus away from the jobs market and towards inflation risks. Guidance from its March meeting turned more hawkish, yet a weaker labour market could still lower the risk of second-round effects, therefore reducing the need for rate hikes. For now, we expect UK interest rates to stay on hold. But, the outlook could shift materially in the six weeks before the MPC meets again in April.

UK employment picture weak as 2026 got under way

The UK unemployment rate stayed steady at 5.2% in January. While it shows how weak the UK labour market was before the Iran conflict, the data did hold some more encouraging news. This suggested the labour market might have been levelling out before Middle East tensions escalated.

While the headline unemployment rate is a three-month average, January’s single-month figure dropped to 5.4% to 4.9%. Some of that reduction may unwind in the coming months as single-month figures can be erratic. However, it could be a sign that the unemployment rate may have been close to peaking. In fact, all three measures of employment have started to show more positive signs. The Labour Force Survey (LFS) measure of employment rose by 84,000 in the three months to January and revisions mean that HMRC payrolls have now risen in the three consecutive months to February.

What’s more, Workforce Jobs data for Q4 show the economy gaining 33,000 jobs at the end of last year. While this chimes with the LFS signal, it contradicts payrolls data, which continued to fall over this period. Either way, payrolls have picked up in 2026. So, we suspect the labour market wouldn’t have had much further to weaken if it weren’t for the energy price shock set to drag on the economy from March onwards.

Looking ahead, rising energy prices will weigh on real incomes, which could prompt a pullback in consumer demand while also pushing up input costs for businesses. This would take the unemployment rate even higher. We now think the unemployment rate will peak at around 5.5%, instead of 5.3%, before declining. That said, if energy prices keep rising higher, then the unemployment rate could easily head towards 6%.

UK rate hikes possible, despite unemployment rate

A weaker labour market means that workers will struggle to bid up wages. Indeed, private sector pay excluding bonuses unexpectedly dropped further to 3.3% from 3.4%. This compared to the pre-data consensus of a rise to 3.5% and contrasts with 2022.

When Russia invaded Ukraine, the ratio of vacancies to unemployed workers – a measure of job market tightness – was one to one. Today, it’s around two-and-a-half unemployed people for each vacancy – the highest since 2014. This substantially lowers the risk of higher energy prices feeding through to higher wages − known as second-round effects. It’s a big reason why we think the MPC will be hesitant to raise interest rates this year. If they do, then the tightening cycle is likely to be brief.

Ultimately, the labour market seemed to be stabilising at the start of the year, but is now likely to weaken further in the coming months as higher energy prices make their way through the UK economy. A softer employment outlook will lessen the risk of second-round effects, which in turn will reduce the degree to which monetary policy will need to be tightened, even if the MPC decides to hike rates.

For now, we expect the MPC to be on hold this year, but the risks are clearly skewed towards interest rate rises.

Related insights