MNI INTERVIEW: Labour Market Weakness May Tame UK Inflation

Evidence is mounting of slack in the UK labour market and wage growth should soon decelerate, as inflation falls to the 2% target by as soon as April, National Institute of Economic and Social Research Deputy Director Stephen Millard told MNI.

While some Bank of England Monetary Policy Committee members, most recently Megan Greene, have expressed concern that firms’ expectations for year-ahead pay growth -- running at 3.7% in the December survey -- have been above levels consistent with the inflation target, Millard said there is clear downward pressure. 

“Tentatively, wage growth has been falling. Reasons for thinking it will fall further, the fall in labour market tightness ... but also, we are going to see a very marked drop in inflation in April. Inflation at the minute is 3.4%. We expect it to drop to two like a stone in April," Millard said in an interview ahead of the BOE’s meeting on Thursday, at which it is also set to publish its annual labour market stock-take.

April’s annual inflation will be lowered by between 1 and 1.25 percentage points due to base effects, including from rises in water and energy bills last year, he noted.

In addition, “some of the announcements in the Budget, particularly on energy prices, mean that we're going to see a further 0.2 or 0.3 percentage point fall in inflation.”

While the Bank’s 2026 Agents’ Pay Survey, to be released alongside the MPC's Feb 5 interest rate decision, will be a key focus for some policymakers, Millard said any downward trend will still need time to become fully apparent. (See MNI INTERVIEW: UK Pay Deals To Cluster Near 3% in '26 -Attwood)

“It may take a bit of time for wages to fall completely to the three or three-and-a-quarter that you might think is compatible with 2% inflation. In our forecast, I think it takes about a year and a half before we get down there. But the direction of travel is fairly clear,” he said.

“Wage growth has been falling, not as fast as obviously the Bank would have liked … People are already seeing the rise in unemployment, slackening in the labour market,” which will loom over future pay negotiations.

VACANCY-UNEMPLOYMENT RATIO

Some MPC members, including Alan Taylor, have supported more accommodative policy out of concern for weakness in the labour market, and Millard noted the vacancy-unemployment ratio is now below its average since 2001.

“In the most recent data, vacancies have bottomed out, but unemployment has continued to rise, so the vacancy-unemployment ratio has continued to fall,” he said.

“Associated with that fall has been a rise in unemployment durations,” he added. (See MNI INTERVIEW: UK Labour Force Survey Now Improved)

LABOUR FORCE GROWTH

“The rise in unemployment has not just been that it's harder to find jobs … but there's also been a greater than usual flow into unemployment from inactivity,” Millard said.

Government efforts to confront the problem of rising economic inactivity since the pandemic appear to have been working, Millard said.

“The government has been aiming to get this to happen via combinations of sticks and carrots,” although it is unclear exactly who has re-entered the labour market. “My hunch is it was the NEETS (young people not in education, employment or training), which I think would be the combination of sticks and carrots actually working.”

ARTIFICIAL INTELLIGENCE

The BOE is also expected to look afresh at productivity, with potential gains from AI, as well as job displacement, a “joker in the pack,” according to Millard, though he said policymakers will be cautious of trying to quantify its effects so far.

“AI seems very good at doing things at entry level,” he noted, although the data on its impact are unclear, and he favoured not factoring in future productivity improvements without clear evidence in their favour. In contrast, official fiscal watchdog the Office for Budget Responsibility has been criticised for repeatedly predicting an uplift in productivity growth which did not materialise. (See MNI INTERVIEW: Brexit Productivity Hit Fades, GDP Hit Stays)

“Should the Bank be prepared to place greater weight on these AI assumptions? Or is it really a case of tread very carefully here, because we are into so many uncertainties?” he mused, adding “I'm very much of the 'I'll believe it when I see it' kind of people.”