(Bloomberg) -- Britain’s unemployment rate rose unexpectedly to the highest in six months as the number of jobs in the economy shrank, an indication that the once red-hot labor market is cooling.

The jobless rate increased to 4.2% in the three months through February from 4% in the period through January, the Office for National Statistics said Tuesday. It was the highest since the summer of 2023.

The figures provided a tentative sign that inflationary pressures in the jobs market are subsiding. But the report also showed pay growth, which the Bank of England is watching carefully, remained stubbornly high, easing to 6%. That was only slightly down from the 6.1% reading previously and above the expectations of economists.

“Weaker activity suggests wage growth will ease more rapidly before long,” said Paul Dales, chief UK economist at Capital Economics. “If it wasn’t for the clear weakening in activity in the labor market, we’d be a bit worried that the UK’s disinflation process is grinding to a halt like in the US.”

The policymakers have been reluctant to signal a shift away from their fight against inflation because of concerns that continued strong pay pressures will fuel price rises. 

What Bloomberg Economics Says ...

“A hotter-than-expected pay print will do nothing to allay fears about the stickiness of wage growth at the Bank of England and dashes any residual probability of a rate cut in May. Still, with growing signs the jobs market is loosening quickly, the central bank can’t afford to delay the easing cycle for too long. With inflation set to fall swiftly in coming months, our base case is that the first move down will be in June, with rates ending the year at 4%. The risk is that sticky wage growth prompts the BOE to move more slowly than we’re expecting.”

—Ana Andrade and Dan Hanson, Bloomberg Economics. Click for the REACT.

Financial markets in recent weeks have scaled back bets on lower borrowing costs coming from the next two BOE meetings. Unexpectedly strong US inflation data and warnings from hawks on the Monetary Policy Committee about similar risks remaining in the UK prompted the shift.

The pound fell as much as 0.3% to $1.2409 after the report. Traders’ bets on BOE interest-rate cuts were little changed, with the market implying two quarter-point reductions by the end of the year. The first move is fully priced by September, with an 80% chance of an earlier step in August.

“Easing pressure in the labor market keeps the bank on track for a summer rate cut,” said Yael Selfin, chief economist at KPMG UK. “The rise in the unemployment rate paints a picture of a less tight labor market. The exact timing of the first rate cut will be a hot debate.”

Readings on the jobs market have been clouded with problems in deriving the official data. The ONS for months has urged caution in interpreting its figures on employment, unemployment and inactivity due to a plunge in the number of responses it receives to its surveys. 

The figures on joblessness seem to be on track with what the BOE is expecting for the full first quarter. The central bank in February forecast unemployment to rise to 4.4% when readings for the first three months of the year are delivered next month.

Nevertheless, Tuesday’s report showed a deterioration in the labor market on a number of fronts:

  • The unemployment rate was pushed up by the UK economy losing 156,000 jobs compared to the previous three-month period, the biggest drop since last August. Economists had expected a gain.
  • Real-time administrative data show the number of employees on payroll fell by 66,661 in March, the biggest drop since November 2020.
  • The redundancy rate — showing firms shedding workers — rose in the three months through February to 3.9 people per thousand employees. That’s up from 3.1 people a year ago.
  • Inactivity — those neither working nor looking for a job — rose in the latest period, driven by those aged 16 to 34 years. These increases were partially offset by more people aged 35 to 49 years returning to the labor market.

However, there were some lingering signs of tightness. A long-running slide in job vacancies ended, with job postings rising to 916,000. Regular private sector wage growth, a key metric of domestic inflationary pressures for the BOE, edged down only slowly to 6%.

Businesses are beginning to shed workers after a protracted period of weak economic activity culminating in a shallow recession in the second half of last year. While the economy is expected to emerge from the recession in 2024, growth is expected to be lackluster again.

“Recent trends of falling vacancy numbers and slowing earnings growth have continued this month albeit at a reduced pace,” said ONS director of economic statistics Liz McKeown. “At the same time, we are now seeing tentative signs that the jobs market is beginning to cool, with both a fall in the headline employment rate from our survey and a drop in the total number of people on payrolls from HMRC data.”

Stronger wage growth along with falling inflation have been a boost for consumers, who are struggling to shake off a cost-of-living crisis that drained personal finances over the past few years. Real regular pay growth based on the headline Consumer Prices Index rose to 2.1%, the highest rate since September 2021.

--With assistance from Isabella Ward, Aline Oyamada, Joel Rinneby and Mark Evans.

(Updates with detail from report.)

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