The labour market in the UK continues to cool off along the lines of what the Bank of England (BoE) expects. Yesterday, the Office for National Statistics (ONS), released its monthly labour market data report, highlighting a rise in the unemployment rate and a reduction in some wage inflation measures.
In their August Monetary Policy Report, the BoE forecast the unemployment rate to rise gradually to just under 5% by the middle of 2026, above its assumed medium-term equilibrium rate of just over 4.5%. With the figure now at 4.8%, the adjustment appears to be progressing slightly faster than the BoE anticipated. Regarding wage inflation, private sector non-bonus pay (the BoE’s favourite metric) grew at 4.4% YoY. While this is still too elevated for the BoE’s comfort, it is nevertheless worth mentioning, as it represents the lowest wage inflation since December 2021. We note, however, that public sector pay is growing more than that of the private sector. While private sector pay is generally a better indicator of underlying economic trends, strong wage growth in the public sector still adds to overall demand in the economy and therefore cannot be entirely ignored.
Job creation was again negative in the month while we note that previous numbers were revised upwards. As in other parts of the world, we suspect that the normalisation of migration figures after several quarters of unusually high levels, is reducing the number of new jobs needed to maintain a stable unemployment rate. The UK labour market is, therefore, cooling off significantly, but not falling off a cliff, despite nine of the last twelve months showing negative job creation. Compared to other countries, however, there is an opposing force that we need to consider. This is the steady decrease in the inactivity rate, which now sits at 21% for the 16-64 year-old cohort, the lowest since February 2020. These are individuals who are neither employed nor actively seeking work. The UK has been an outlier post-pandemic, as people were slower to return to the workforce than in other parts of the world. While 16–64-year-old male inactivity rates are declining, at 17.8%, they remain somewhat above pre-pandemic levels. Women, on the other hand, at 24.2% for the same cohort, are at all-time lows in inactivity as the graph below shows. As more people enter the labour force, the unemployment rate increases, all else equal. As strange as it sounds, a temporary rise in unemployment is not necessarily harmful if it occurs because more people are rejoining the workforce.
The BoE should have at the margin, an easier path to cut rates given these labour market figures. We would not, at this stage, be willing to put many chips on the table for a cut this year necessarily, but it is fair to say that the probability has increased. In the next few months, it is likely we see inflation coming down from levels of close to 4%, while at the same time wage inflation might continue moving downwards. With GDP growth being far from spectacular and growing anxiety as the budget date approaches, it is not unreasonable to consider lowering rates. Just to be clear, a rate cut slightly earlier than what was expected a few weeks ago would not materially change the fiscal situation and would have little impact on what Chancellor Reeves might or might not say when the 2026 budget is unveiled next month.
Gilts have reacted accordingly, outperforming other G7 government curves after the news. Although the boom in Gilts might continue, we would rather be exposed to high quality corporates on the sterling curve that would benefit from a rally in the Gilt curve and lower rates across the economy, but are more insulated from the vagaries of the budget, debt-to-GDP ratios, and UK politics in general. In any case, a steady yet controlled cooling of the labour market is exactly what the BoE intended, when they embarked in a hiking cycle some quarters ago. As long as this trend remains under control (which cannot be taken for granted) and unemployment plateaus around 5%, we believe the BoE would welcome this data, as it allows them to take rates down to neutral and protect growth, while still maintaining their objective of keeping inflation in check. Maybe we get a nice early Christmas present from Andrew Bailey & Co.
