The Bank of England has held interest rates unchanged at 3.75% while projecting the unemployment rate will climb to 5.3% this year, higher than the 5% previously forecast. This deteriorating labor market outlook is influencing the debate about future rate cuts.
The monetary policy committee’s 5-4 vote to maintain rates came despite the weaker unemployment forecast, with four members believing labor market softening already justified immediate easing. The close division reflects disagreement about whether rising unemployment warrants rapid policy response or whether inflation concerns require continued caution.
The projected increase in unemployment from 5% to 5.3% represents a meaningful deterioration in labor market conditions. The Bank attributes this partly to the impact of higher employer costs, including increased national insurance contributions and the rising minimum wage, which have contributed to flat employment growth over the past year.
While rising unemployment is concerning from a growth perspective, some policymakers view it as helpful for controlling inflation. The Bank expects labor market softening will moderate wage growth, reducing the risk that strong pay increases perpetuate high inflation. This represents one reason why the majority voted to hold rates despite the unemployment increase.
Governor Andrew Bailey emphasized the positive inflation outlook, projecting it will fall to around 2% by spring. He suggested that conditions should allow for rate cuts during the year, which would help support the labor market. The Bank forecasts GDP growth of just 0.9% this year, down from 1.2% previously. Chancellor Rachel Reeves’s budget measures, including utility bill cuts and rail fare freezes from April, are expected to drive inflation down to 2.1% by mid-2026, compared to 3.4% in December.