UK QUARTERLY ECONOMIC OUTLOOK | Q3 2025
Labour market
Labour market loosening, not collapsing
While the ONS’s well-publicised data quality issues make it difficult for anyone to get a crystal-clear read on the UK labour market, when we piece together the data it looks like employment growth has weakened, rather than collapsed. There’s also no sign of the feared surge in unemployment, although most measures of employment remain weak. In any case, a looser labour market should continue to weigh on pay growth over the rest of this year.
Slow growth, high costs and a weakening labour market
The caveat to our labour market outlook is that nobody has a particularly accurate view of what is happening right now. That’s because different data sources are painting very different pictures of the labour market.
The Labour Force Survey (LFS), which is the UK’s official source of employment data, has been plagued with quality issues since the pandemic. It suggests employment has grown 1.2% since the last Autumn Budget and the unemployment rate has only ticked up gradually to 4.7%.
Yet, payrolls data suggest a 0.5% fall in employment over the same period, pointing to a much quicker loosening.
'Yet, payrolls data suggest a 0.5% fall in employment over the same period, pointing to a much quicker loosening.'
Some of this difference is because the LFS captures a broad range of employment, including many self-employed workers, whereas payrolls data only captures employees. Given April’s increase in employment costs, it may be that many more workers are becoming self-employed.
However, this doesn’t account for most of the difference between the two data sources. So, it seems a portion of the drop in payrolls represents a genuine reduction in employment as firms adjust to higher costs. Indeed, it’s no coincidence that the biggest loss in employee numbers has been in exactly those industries with the highest proportion of low-paid workers, such as retail and hospitality (see chart).
Looking ahead, it seems most of the initial adjustment to employment cost hikes has now happened. Surveys have stabilised and the falls in payroll numbers have slowed dramatically. However, labour demand remains tepid. Even though the figures have recovered somewhat, most surveys are still pointing to very weak employment growth. As a result, the unemployment rate is likely to continue to gradually tick up until it reaches around 5%.
Lower pay growth
We expect total wage growth (average weekly earnings, including bonuses) to slow from its current 4.6% rate for three key reasons.
First, strong wage growth last year will fall out of the annual comparison. These base effects will naturally drag wage growth down.
Second, that extra slack from weaker labour demand and slightly higher unemployment will make it harder for workers to bargain for big pay rises as competition among firms for employees fades.
Third, firms will be under pressure to protect their profit margins after April’s rise in employment costs and will want to try and pass some of that cost onto employees through less generous pay rises.
However, we see a couple of big risks to this outlook for slower wage growth. First, rising inflation expectations might prompt employees to bargain for higher wages. Indeed, inflation will hit 4% soon and employees have shown a greater reluctance to accept falls in their real incomes after years of above-target inflation.
Ultimately, we expect only a slow and steady increase in the unemployment rate going forward. We also expect that a weaker labour market and firms trying to recoup the rise in employment costs means pay growth ends the year at around 4%, which would still be higher than the MPC is comfortable with.
