UK Labour Market in Fragile State Despite Unemployment Drop
New data reveals the UK jobs market is in a precarious position, even before the Iran conflict threatened to derail the nation's nascent economic recovery. According to the Office for National Statistics, the unemployment rate fell to 4.9% in the three months to February, down from 5.2% in the previous quarter. This surprise decline might suggest an improvement in the labour market, aligning with a slight uptick in economic growth observed in February.
Underlying Weaknesses and Economic Inactivity
However, beneath the headline figures, signs of weakness persist. The fall in unemployment was accompanied by an increase in economic inactivity, referring to individuals not actively seeking work for various reasons. Additionally, payrolled jobs, a separate measure of employment, continued to decline, with provisional data for March showing a drop of 65,000 compared to the same month last year.
Sanjay Raja, the chief UK economist at Deutsche Bank, cautioned against optimism, stating, "Despite the labour market seemingly entering the Iran conflict on better footing, we would caution on any optimism just yet. Indeed, underneath the hood, and beyond the headline unemployment rate, signs of weakness continue."
Wage Growth Hits Lowest Level in Five Years
Weak wage growth indicates that UK workers are already feeling the pinch, with a looming price shock as the Strait of Hormuz remains closed. Total annual pay growth in the three months to February stood at 3.8%, its weakest since autumn 2020 during the pandemic. In the private sector, regular pay growth excluding bonuses was just 3.2%.
When adjusted for inflation, a proxy for living standards, total pay growth was a measly 0.7%, the weakest since mid-2023. This minimal increase is hardly conducive to a feelgood factor, especially as petrol prices begin to rise, and it may dampen voter enthusiasm for upcoming local government elections in Scotland, Wales, and England.
Pressure on Policymakers and Economic Forecasts
The weak jobs market suggests workers are unlikely to successfully bid for higher wages in the coming months to weather economic storms. Peter Dixon, a senior economist at the National Institute of Economic and Social Research, noted, "Although price inflation is set to accelerate, workers may struggle to push for higher wages in the face of company resistance."
Recent forecasts indicate unemployment is poised to rise through 2026, as knock-on effects from the war crimp economic growth. This shaky jobs picture may, however, dampen concerns at the Bank of England's Monetary Policy Committee about "second round effects," where wage increases could lead to a dreaded wage-price spiral.
Interest Rate Implications and Future Outlook
With the MPC meeting next week, fears of inflation might lead some members to argue for higher interest rates to slow the economy. Yet, with wage growth at its weakest in five years and a mixed employment picture, hawks may struggle to win the argument. Dixon predicts, "Relatively limited second-round effects will limit the need for the Bank of England to tighten policy aggressively, although we do expect at least one rise in the coming months."
Others, like Thomas Pugh, chief economist at RSM, expect rates to remain on hold at 3.75% for an extended period, contrary to earlier forecasts for cuts before the Middle East conflict. Pugh said, "The weak labour market substantially lowers the risk of higher energy prices feeding through into higher wages as they did in 2022 as evidenced by slowing pay growth. The base case is still for a prolonged interest rate hold, rather than a series of rate hikes, unless inflation goes substantially higher."
While this may limit additional pain from higher interest rates, weak wage growth means the looming cost of living squeeze will be keenly felt by UK workers, highlighting the fragile state of the economy.
