UK labour market weakens ahead of April tax rises

The drop in the number of people on company payrolls is the biggest since the pandemic. The figures will be revised up, but the shift still points to a significant weakening in the labour market as higher employment taxes start to take effect. 

Pay growth remains persistently high, but underlying momentum looks to be cooling. With the drag on growth from new US tariffs and higher uncertainty, we think a May rate cut is a sure bet. 

Unreliable employment data obscures the view

Employment rose by 206,000 in the three months to February. This was accompanied by a stable 4.4% unemployment rate. However, the Labour Force Survey is officially unreliable at the minute so it’s difficult to take this data at face value. 

Crucially, payrolls showed a drop of 78,000 in March. That would be the biggest drop since the pandemic. While payroll data is volatile and usually heavily revised, last month’s figures were also revised to a drop of 8,000 from an initial rise of 21,000.

Even if it is revised up, this March figure suggests firms took a conscious decision to shrink their workforces ahead of April’s tax rises and its chunky increases in National Minimum (NMW) and Living Wages (NLW). Indeed, the traditionally lower-paid hospitality and retail sectors saw the largest drops in employment with both trimming their payrolls by a headcount of around 17,000 each. 

Vacancies continued to trend down with March suggesting another drop of 26,000. That implies labour demand is still cooling and should eventually feed through into a period of slack. Interestingly, the unemployment-to-vacancy ratio did tick up to 2.0 from 1.9. 

Wage growth remains stubborn

As labour demand continues to moderate, we should see that feed into a more material cooling of stubbornly high pay growth. This is still high at 5.9% for both the whole economy and the private sector. 

This will continue to make the Bank of England (BoE) hesitate when thinking about further rate cuts. It needs to drop to around 3% to be consistent with 2% inflation. 

We do think underlying momentum on wage growth is easing. Comparing 3m/3m, regular private sector pay growth is now around 4.3% on an annualised basis. If that is maintained and the rise in April’s payroll taxes does feed through into softer demand for labour, then it should dampen growth further and eventually show in the official data. 

However, in the near term we expect to see some upwards pressure in the headline rate from the increases to the NMW and NLW pushing up the bottom end of the distribution.

What does this mean for interest rates?

Overall, there are clear signs the labour market has materially weakened, which should eventually slow wage growth. What’s more, the ongoing tariff chaos will drag on economic growth and employment, making a cut in May a sure bet. 

However, surveys suggest pay growth expectations are still around 4%. Coupled with already high wage growth now, the BoE will need to be careful not to turn too dovish too quickly and unleash second-round effects when inflation picks up later this year. 

Ultimately, we still expect two more cuts after May, with the Monetary Policy Committee shifting slightly away from the hawkish tone they struck at the last meeting in the face of tariffs. That would leave interest rates at 3.75% by the end of the year.