UK unemployment rate unexpectedly rises, markets bet on Bank of England rate cut in December, autumn budget under pressure.

The UK labor market unexpectedly weakened, adding pressure on policymakers ahead of year-end interest rate cuts and the release of the key budget.

Data released by the UK Office for National Statistics on Tuesday (November 11) showed the unemployment rate for the three months to September rose to 5%, above market expectations, and the number of salaried employees (those employed by employers and paid wages for work) fell by 32,000 during the same period. After the data was released, the market’s bets on a Bank of England rate cut in December rose to 75%, 10-year UK government bond yields fell more than 5 basis points to 4.405%, and the pound fell 0.3% against the dollar.

This increased slack in the UK labor market comes just as Chancellor Rachel Reeves is preparing to unveil the autumn budget. Analysts pointed out that economic vulnerability will force the government to implement tax hikes during a weakening economy, which runs counter to widely accepted economic theory. But given that welfare reform has already been ruled out, the government lacks obvious policy alternatives.

The UK currently has the highest long-term government borrowing costs among G7 nations, with 30-year government bond yields significantly above the critical 5% threshold, further limiting the room for fiscal maneuver.

Unemployment Rate Surpasses Expectations, Market Significantly Raises Rate Cut Forecast

The latest UK data shows that the unemployment rate for the three months to September rose to 5%, above previous forecasts. At the same time, between August and September, the number of salaried employees was estimated to have decreased by 32,000.

Sanjay Raja, Chief UK Economist at Deutsche Bank, noted after the data release that labor market slack continues to expand, exceeding market expectations. He said, despite budget uncertainties possibly hindering fourth-quarter hiring plans, one thing is clear: today’s data should continue to strengthen the case for a Christmas interest rate cut.

Raja said that both Deutsche Bank and the Bank of England had previously expected the unemployment rate to rise to 4.9%. He said, leaving aside any revisions, today's data reflects two points:

First, the labor market is accumulating more slack, possibly exceeding the Monetary Policy Committee’s November forecast; second, wage growth momentum continues to slow.

After the data release, financial markets now see a 75% probability of a Bank of England rate cut at the December meeting.

Grant Slade, UK economist at Morningstar, said Tuesday’s data increases the likelihood of a rate cut as it provides further evidence of mounting economic slack. He expects further normalization of interest rates by 2026 and that the UK’s disinflation process remains on track.

UK inflation for October stood at 3.8%, below expectations but still well above the Bank of England's 2% target. The Bank maintained interest rates at its November meeting.

Autumn Budget Faces Double Pressure

Julian Howard, Chief Multi Asset Investment Strategist at GAM Investments, said conditions in the UK labor market are adding further pressure on Chancellor Reeves ahead of the key autumn budget.

Howard pointed out that today’s unemployment data increases the pressure on both the government and the Bank of England to change course—with calls to relax tax hikes and interest rate cuts, respectively. But neither is simple. The government must find a way to address the country’s dire fiscal situation without stifling market vitality.

Reeves will unveil the autumn budget on November 26, and it’s widely expected that she will break the campaign pledge not to raise taxes on workers. She has been under continued pressure since last year’s budget, when she announced strict rules limiting the government’s room for spending and borrowing.

Under her fiscal rules, everyday government spending must be funded by tax revenues rather than borrowing, and she has pledged to ensure that the ratio of public debt to economic output declines by 2029-30.

Howard warned that income tax, pensions, individual savings accounts, and housing are all under consideration, but the challenge lies in the fact that squeezing these areas will suppress consumption and business vitality to varying degrees.

With the unemployment rate now starting to rise, economic vulnerability is further highlighted. As a result, the government will be forced to implement tax hikes during a weakening economy, which runs counter to widely accepted economic theory. But since welfare reform has been ruled out, there is no clear political alternative.

Earlier this year, the ruling Labour Party’s attempt to cut UK welfare spending was opposed by party MPs, forcing the government to ease planned measures intended to fill billions of pounds of fiscal shortfall.

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