UK labour market deteriorates further

The latest UK employment data shows that the labour market ended 2025 on a weak note. The unemployment rate rose to 5.2% in the three months to December, the highest level since 2021. This is boosting the chance of a rate cut from the Bank of England next month, with more than two rate cuts now priced in for 2026.  

The ONS also reported that the number of payrolled workers fell further in the last three months of the year, as hiring activity remains weak. The vacancy rate remained broadly unchanged, which means that the number of unemployed people per vacancy has increased, and the ONS has also noted that redundancies are seeing an upward trend.

Wage growth moderates

Wage growth also moderated, private sector pay growth was in line with expectations at 3.4% for the three months to December, this is the lowest rate for 5 years, as covid-era wage gains continue to work their way out of the system. Pubic sector wage growth also moderated to 4.2%, down from 4.4% in November. The ONS reports that public sector wage growth remains elevated due to the government’s large pay awards for the public sector in early 2025, although the effect of public sector wage growth is starting to diminish.

Will unemployment surpass covid peak?

The rise in the unemployment rate at the end of last year is concerning, since the jobless rate is now close to the 5.3% peak during the height of Covid in 2023. The Bank of England expects the unemployment rate to peak at 5.3% in Q2 and to remain at this elevated level for some time. The risk is that the unemployment rate will exceed the BOE’s estimate and the labour market could deteriorate from here as hiring costs and progress in AI weighs on the UK labour market. The UK’s unemployment rate is now significantly higher than the rate in the US, but it is below the Eurozone’s rate of 6.2%, and it is still well below France’s rate of 7.7%, which is the highest in the G7.

Today’s labour market data leads to some uncomfortable questions for the government. Have their policies caused unemployment to rise, including payrolls taxes and a large rise in the minimum wage, and why haven’t the 6 rate cuts from the BOE in recent months been effective at helping firms to hire?

GBP sinks to the bottom of the G10 FX pile

The market reaction has been swift. The pound has sunk on this news, GBP/USD is down by 70 points and it has lost the $1.36 handle. It is the weakest currency in the G10 FX space on Tuesday, and the pound is now trailing behind the dollar, and is the weakest currency in the G10 so far this month. As the UK economy softens, the bias is to the downside for sterling. $1.3525 is the first key support level, below that opens the way towards 200-day sma support at $1.3445.  The relentless selling of the pound in recent weeks, leaves it vulnerable to testing this important support level.  

The Bank of England to the rescue

UK bond yields have been trending lower in the past month as the UK’s economic picture has deteriorated, today’s data could add to downward pressure on yields. The interest rate futures market has also increased expectations for a rate cut next month, there is now an  80% chance of an interest rate cut in March, and a strong chance of a subsequent cut in June or July.

Tomorrow’s CPI report is expected to support calls for the BOE to stimulate the UK economy, as inflation moderates at the same time as the labour market is weakening.

Will the AI scare trade continue to grip markets?

Elsewhere, there is a downbeat tone to overall markets today and global equity futures are lower, although the FTSE 100 is bucking this trend and is expected to rise this morning. The US comes back from Presidents Day today, and the focus will be on whether the AI scare trade takes a breather, or if it continues to weigh on sectors believed to be vulnerable to new developments in AI technology.

Chart 1: GBP/USD looks vulnerable

Source: XTB and Bloomberg