UK QUARTERLY ECONOMIC OUTLOOK | Q4 2025
Labour market
Employment weak, but pay growth sticky
Although the ONS’s well-publicised data quality issues make it difficult for anyone to get a crystal-clear read on the UK labour market, it undoubtedly weakened last year. The worst is probably behind us. However, we doubt the unemployment rate will drop back quickly. Wage growth should slow a little further, but big increases in the National Minimum Wage (NMW) will keep it elevated.
UK labour market to show slight improvement in 2026
The unemployment rate rose steadily last year from 4.4% at the start to 5.1% in October (the latest available data). Ongoing data quality concerns mean while we take that number with a pinch of salt, we can see subdued demand for hiring in other official data sources.
Claimant count and redundancy figures were relatively stable, suggesting firms weren’t shedding staff, but not hiring them either. This will have peaked in the run up to the Autumn Budget when rumours of more taxes were rife. Indeed, the employment balance for November’s Bank of England’s Decision Maker Panel survey was the weakest since July 2021.
However, given no significant tax rises were announced in the Budget that come into effect this year and the government has also rowed back on the most controversial sections of the Employment Rights Bill, we expect the UK labour market to recover a little through 2026 as firms regain some confidence. Indeed, before the Budget, labour market surveys were starting to pick up again and job vacancies are rising again on some measures.
That said, a high minimum wage, subdued economic growth and the fact that the labour market is a lagging indicator all mean the unemployment rate will probably only come down gradually this year and next.
UK pay growth to stay sticky in 2026
The 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. What’s more, the sharp drop in inflation expected in Q2 will reduce the need for employers to give inflation-busting pay rises. Firms will also still be under pressure to rebuild their profit margins after last April’s rise in employment costs. They’ll want to try and pass some of that cost onto employees through less generous pay rises. However, the big increase in the NMW, especially for 18−20 year olds, will prevent many firms rebuilding their margins this way. The NMW rise supports wider pay growth. This is because pay bands have become so compressed that any rise in the NMW needs to be passed on to higher earners to keep pay grade differentials intact.
Ultimately, we expect only a gradual reduction in pay growth this year and into 2027 as the cyclical rise in the unemployment rate is partly offset by structural factors supporting pay growth. However, given higher inflation, real wage growth is set to average less than 1% over the next two years.
