UK unemployment forecast to hit 5% – with a slowdown in earnings expected
Inflation has risen since July’s Summer Forecast and held at 3.8% in September, with fuel and food price inflation continuing to put pressure on the headline rate.
The EY ITEM Club now predicts that inflation has reached its peak and that the headline rate will cool gradually through Q4 2025, averaging 3.4% in 2025 and 2.7% across 2026. Inflation is expected to reach the Bank of England’s (BoE) 2% target from 2027.
Unemployment is forecast to continue its slow rise due to elevated labour costs, peaking at 5% in the first half of 2026. However, this is expected to be a temporary increase and far below the 8% level seen at the height of the 2008 global financial crisis. Unemployment is expected to fall back to 4.7% by 2027.
The small rise in the unemployment rate in 2025 is forecast to drive a further slowdown in earnings this year, with pay growth expected to fall back to around 3.5% by the end of 2025 and 3% by the middle of 2026.
Consumer spending remains modest and this is forecast to weigh on growth. However, a small rise in household consumption is expected over the coming years as the effects of energy price increases fade and falling interest rates persuade more households to spend rather than save. Consumer spending is predicted to rise by 0.9% in 2026 and 1.4% in 2027.
“To meet its fiscal rules, the Government will need to reduce borrowing by up to £30 billion by increasing tax revenue or making spending cuts. Some of these changes would need to be introduced almost immediately, although we can expect potential tax rises to be balanced with supply side growth measures,” said Matt Swannell, Chief Economic Advisor to the EY ITEM Club.
“Nevertheless, the combination of potential tax rises, global trade disruption and high interest rates is still anticipated to put a brake on economic momentum and produce modest growth over the next year.
“Rises in energy, food and regulated prices has kept inflation persistently high, but we’ve likely passed the peak. With services inflation set to come down gradually and pay growth easing, inflation should fall back to the Bank of England’s 2% target by the end of next year.”
