However, the already tight jobs market will limit how far unemployment rises.
According to EY chief economic adviser, Martin Beck, the drop in inactivity was a strong indication the labour market is loosening, but he noted that cash pay continued to rise strongly.
“A combination of a weak economy and falling inflation should supress pay growth, encouraging the Monetary Policy Committee (MPC) to dial back the pace of rate increases,” he said.
The Labour Force Survey unemployment rate stood at 3.7 per cent in the three months to November, up 0.2ppts from the previous three months, with a fall in inactivity more than offsetting a small gain in employment.
“Evidence of softer demand for workers has not yet fed through to the price of labour,” Mr Beck said.
“Annual growth in average total and regular weekly wages was 6.4 per cent year-on-year in the three months to November, the latter a record high outside the pandemic period. But average pay continued to fall heavily in real terms.
“On balance, the latest numbers won’t dissuade the Monetary Policy Committee from continuing to raise interest rates. But more evidence of a loosening jobs market might encourage a dialling back of the pace of tightening.
“The recent decline in inactivity might continue if cost-of-living pressures compel some inactive people to enter, or re-enter, the workforce. As to how far unemployment might rise, with vacancies still high by historical standards and surveys continuing to point to a shortage of workers in some sectors, employers may choose to hold on to labour during the downturn.”
Jake Finney, economist at PwC UK, said small rises in redundancies and unemployment, alongside falling vacancies, provide the strongest evidence yet that the labour market is cooling.
“Redundancies increased by 30,000 on the quarter while unemployment increased by 56,000, albeit both from low starting points. At the same time, the number of vacancies fell for the sixth consecutive quarter, leaving them down 11 per cent from their peak, which points towards weakening demand for labour,” he said.
“High inflation continues to squeeze real pay, which fell by 2.6 per cent on the year. However, if inflation continues to fall back from its pandemic highs, as is expected, the squeeze on real wages should start to ease in the second half of 2023.
“More positively, inactivity continues to gradually fall back to more normal levels. The number of inactive workers has now fallen for three consecutive periods, with 66,000 inactive workers returning to the labour market over the past quarter. In our latest UK Economic Outlook, we predicted that at least 300,000 inactive working age adults would return to the labour market over the next year.
“Going forward, we expect that the labour market will continue to cool as the recession takes hold. The unemployment rate is likely to continue rising, potentially peaking at around the 5 per cent mark that was reached during the pandemic.”
Yael Selfin, chief economist at KPMG UK, said the wave of public sector strikes resulted in nearly half a million working days lost in November, with average hours worked falling by 1 per cent on the previous quarter.
“The availability of labour has likely come under further pressure around the turn of the year, with the industrial action gathering momentum on top of the ongoing squeeze on the labour force due to early retirement and ill health,” Ms Selfin said.
“Continued frictions in the labour market have kept the unemployment rate low, but this is set to reverse as employers adjust their headcount in light of rising costs and falling demand. We expect the unemployment rate to peak at around 5.6 per cent by the middle of next year.
“Regular pay growth picked up to 6.4 per cent, its highest rate since mid-2021 when it was boosted by the unwinding of furlough effects. Together with last week’s stronger than expected GDP data, we anticipate this will provide enough evidence for the Bank of England to clinch another interest rate increase at its February meeting.”
