UK unemployment data adds pressure to Reeves

U.K. assets were volatile in morning trade on Tuesday, as investors weighed the economic impact of a weakening labor market ahead of a critical budget and the final interest rate decision of the year.

Data released by Britain’s Office for National Statistics (ONS) on Tuesday showed that the country’s unemployment rate rose to a higher-than-expected 5% in the three months to September. Meanwhile, the estimated number of payrolled employees in the U.K. fell by 32,000 between August and September.

By 11:20 a.m. in London (6:20 a.m. ET), yields on U.K. government bonds — known as gilts — had fallen notably across the curve. The yield on the benchmark 10-year gilt was over 5 basis points lower at 4.405%, as bets on an end-of-year rate cut from the Bank of England rose.

Bond yields and prices move in opposite directions. The U.K. has the highest long-term government borrowing costs of any G-7 nation, with its 30-year gilt trading well above the crucial 5% threshold.

The British pound, meanwhile, fell 0.3% against the U.S. dollar to trade at around $1.313, and was 0.4% lower against the euro.

In a note following the release, Sanjay Raja, chief U.K. economist at Deutsche Bank, said Tuesday’s data release should give the Bank of England’s Monetary Policy Committee confidence to cut its key interest rate before the year is out.

“Labour market slack continued to widen — even surprising market expectations,” he said. “While Budget uncertainty may be hampering hiring plans heading into Q4-25, one thing is clear: today’s data should continue to strengthen the case for a Christmas rate cut.”

Financial markets are now pricing in a 75% chance of a rate cut at the Bank of England’s December meeting, according to LSEG data.

Raja noted that Deutsche Bank, like the Bank of England, had been anticipating the unemployment rate to pick up to 4.9%.

“Big picture, bar any revisions, today’s data speaks to two things: one, there’s more slack building in the labour market – and perhaps more so than assumed by the MPC in its November projections; and two, pay momentum continues to slow,” he said.

“Today’s data should give the majority of the MPC some added confidence that weakness in the labour market is translating into weaker pay momentum, which should ultimately feed through into inflation in the months and quarters to come.”

Grant Slade, U.K. Economist at Morningstar, agreed that the figures published on Tuesday made lower interest rates more likely, as they offer additional evidence that slack continues to build in the economy.

“We expect further interest rate normalization in 2026, with the disinflationary process in the U.K. still alive and well,” he told CNBC in an email.

U.K. inflation hit 3.8% in October, which was cooler than expected but still notably higher than the Bank of England’s 2% target. The central bank held rates steady at its November meeting.

Julian Howard, chief multi-asset investment strategist at GAM Investments, told CNBC that the shape of the U.K. labor market adds further pressure to Finance Minister Rachel Reeves as her critical Autumn Budget looms.

“Today’s unemployment numbers increase the pressure on both the government and the Bank of England to change course and go easy on the tax rises and cut rates respectively,” he said. “But neither is straightforward. The government somehow has to fix the dire fiscal position the country finds itself in without strangling animal spirits.”

Reeves is due to deliver her Autumn Budget on Nov. 26, and is widely expected to break an election manifesto pledge not to raise taxes levied on working people.

She has come under sustained pressure since last year’s budget, when she announced strict rules that limited the government’s room for maneuver on spending and borrowing. Under her fiscal rules, day-to-day government spending must be funded by tax revenues and not borrowing, and she has also pledged to ensure public debt is falling as a share of economic output by 2029-30.

The finance minister has been considering a range of ways to shore up public finances, from taxing dividends to imposing higher levies on certain professions, according to reports from local media outlets.

“Income tax, pensions, ISAs, housing are all in scope, but the challenge is that squeezing these will have a dampening effect on consumption and enterprise to varying degrees,” Howard cautioned.

“With unemployment now ticking up, the economy’s fragility is only further highlighted with the result that the government will be forced to impose tax rises into a weakening economy, contrary to widely held economic doctrine. But there is no obvious political alternative given that welfare reform is off the cards.”

Attempts by the governing Labour party to cut the U.K.’s welfare bill earlier this year were met with rebellion from its own lawmakers, forcing the government to water down cuts it had planned to make to plug a multi-billion-pound hole in the government purse.

“Markets logically appear to be pricing in the low growth story – and possibly lower rates in time – with cable weakening and the 10-year gilt yield [falling],” GAM’s Howard said of the reaction in financial markets on Tuesday.

“The assumption of course being that the Budget will plough on regardless and growth will have to adjust accordingly – downwards.”