Britain’s labour market is sending a clear signal: something’s shifted. The unemployment rate has climbed to 5.2%: the highest level in five years: while wage growth has cooled to 4.2%. For economists, policymakers, and the Bank of England, these aren’t just statistics. They’re markers of a fundamental change in how the economy is behaving, and they’re raising urgent questions about what comes next.
The latest Office for National Statistics (ONS) data paints a picture of a labour market in retreat. The number of unemployed people has reached 1.883 million, up 0.2 percentage points from November and nearly a full percentage point from the 4.4% recorded a year earlier.
Meanwhile, the employment rate has slipped to 75.0%, and payrolled employees have fallen for the fifth consecutive month: down 11,000 in January 2026 alone.
This isn’t a temporary blip. It’s a sustained contraction in hiring, and it reflects a fundamental shift in employer confidence. After years of competition for talent, businesses are now pulling back: hesitant to take on new staff in an environment marked by rising costs, economic uncertainty, and structural change.
The £25 Billion Question: Did the Budget Break the Camel’s Back?
One of the biggest elephants in the room is the October 2024 Budget, which introduced a £25 billion increase in employer National Insurance contributions. The hike was framed as a necessary measure to shore up public finances and fund critical services, but its timing couldn’t have been worse for businesses already grappling with stagnant growth and squeezed margins.
For many employers: particularly in labour-intensive sectors like hospitality, retail, and care: the NI increase represented a direct hit to their ability to maintain or expand their workforce. Hiring has become more expensive overnight, and firms that were already teetering on the edge of profitability found themselves forced to reconsider headcount plans.
The subsequent budget and spectre of new employment rights legislation, adding an additional £5 billion to cost has not helped
These ripple effects are now showing up in the data. Consumer-facing industries, which typically drive a significant portion of employment growth, are experiencing particular weakness. Hiring surveys continue to deteriorate, and redundancies have climbed to 145,000 in the three months to December: a level Deutsche Bank describes as “worrying.”
The government’s position has been to point to the “economic inheritance” it received: a shorthand for the fiscal mess left behind by previous administrations. And there’s truth to that narrative. But inheritance or not, businesses are dealing with the here and now, and the NI hike has undeniably added to the pressure they face.
The Young Bear the Brunt
While the unemployment rate is climbing across the board, younger workers: particularly those under 34: are bearing the brunt of the slowdown. Entry-level positions, graduate schemes, and junior roles are disappearing faster than at any point since the pandemic recovery, and it’s not hard to see why.
Younger workers are disproportionately employed in sectors hit hardest by the Budget’s tax changes and broader economic uncertainty. Hospitality, retail, and the gig economy: traditional first-rung employment sectors: are contracting rapidly. Employers in these industries are cutting back on new hires, offering fewer hours, or, in some cases, closing altogether.
But there’s another, less visible force at play: automation and AI integration. The convergence of higher labour costs and rapidly improving AI tools is creating a perfect storm for entry-level hiring. Tasks that once required a junior employee: customer service queries, data entry, basic administrative work: are increasingly being handled by software. And as the cost of human labour rises, the business case for investing in technology strengthens.
This isn’t a hypothetical trend. It’s happening right now. From chatbots replacing call centre staff to AI tools streamlining back-office functions, businesses are making calculated decisions to automate rather than hire. For young people trying to break into the workforce, this represents a shrinking ladder: fewer rungs, and those that remain are increasingly out of reach.
The irony is cruel: the generation that grew up with technology is now finding itself displaced by it.
Services Sector Stagnation and the Spiral Effect
Britain’s economy is overwhelmingly services-led, and when the services sector stagnates, the knock-on effects are severe. Analysts are describing the current labour market not as a “spurt” but as a “spiral”: a self-reinforcing cycle where weak demand leads to hiring freezes, which in turn reduces consumer spending power, which further weakens demand.
The Bank of England’s own forecasts reflect this concern. In its February outlook, the BOE raised its peak unemployment forecast to 5.3% by mid-2026, suggesting policymakers expect further deterioration before any stabilisation occurs. Some analysts are even more pessimistic, projecting the rate could drift toward 5.5% throughout the year.
What makes this particularly troubling is the pace of change. A year ago, the unemployment rate sat at 4.4%. Within twelve months, it’s jumped nearly a full percentage point. That’s not gradual cooling: it’s a sharp deceleration, and it suggests the economy is weakening faster than many expected.
The Bank of England’s Response: Rate Cuts on the Horizon
For the Bank of England, the softening labour market presents both a challenge and an opportunity. On one hand, rising unemployment and falling wage growth ease inflationary pressures: particularly in the labour-intensive services sector, where pay increases have been a key driver of persistent inflation. On the other hand, they signal underlying economic weakness that could tip into something worse if left unchecked.
Wage growth has now cooled to 4.2%, down from 4.4% previously. While that’s still above the Bank’s 3.25% target for wage growth consistent with 2% inflation, the gap is closing. And with unemployment rising, the downward pressure on wages is likely to intensify.
Most investors now expect the Bank to cut its benchmark interest rate in March, and multiple further cuts are forecast throughout 2026. The logic is straightforward: with inflation easing and the labour market weakening, the case for maintaining restrictive monetary policy has evaporated. Rate cuts could help stimulate demand, support business investment, and hopefully arrest the spiral before it accelerates.
But there’s a trade-off. Lower interest rates won’t reverse the structural challenges facing the labour market: the NI hike, the AI-driven automation, the stagnation in key sectors. They can ease financial conditions, but they can’t create jobs on their own. That requires a broader policy response.
Government Stance: Inheritance Versus Action
The government’s messaging has leaned heavily on the “economic inheritance” framing. Ministers have repeatedly pointed to the fiscal challenges left by previous administrations, positioning their actions: including the controversial NI increase: as necessary correctives rather than policy missteps.
There’s political logic to this approach. It shifts blame and sets expectations. But for businesses facing rising costs and workers facing redundancy, the narrative of inheritance offers little comfort. What they want to know is: what’s being done now to reverse the trend?
So far, the active measures have been limited. There’s talk of skills programmes and support for sectors hardest hit, but no major policy pivots. The Budget set a course, and the government appears committed to sticking to it: at least for now.
The risk is that by the time the full impact of current policies becomes clear, the labour market will have deteriorated to a point where recovery becomes far more difficult. Unemployment isn’t just an economic metric; it’s a social and political one. The longer people are out of work, the harder it becomes for them to re-enter the workforce, and the more pressure builds on public services and social cohesion.
What This Means Going Forward
Britain’s labour market is at a crossroads. The 5.2% unemployment rate and cooling wage growth signal a clear shift from the tight, competitive conditions of recent years to a softer, demand-constrained environment. Employers are cautious. Workers: particularly younger ones: are struggling. And the Bank of England is preparing to ease monetary policy in response.
But beneath these immediate dynamics lie deeper structural questions. How much of this slowdown is cyclical, and how much is the result of policy choices like the NI hike? How quickly will AI and automation reshape entry-level employment, and what does that mean for a generation trying to build careers? And can the government shift from a defensive “inheritance” narrative to proactive measures that genuinely support job creation and economic growth?
The answers to these questions will shape not just the next few months, but the trajectory of Britain’s economy for years to come. The 5.2% squeeze isn’t just a number: it’s a warning. And the clock is ticking.