A worsening UK labour market raises the chance of the Bank of England cutting interest rates, but it is more likely to be in August than the meeting next week, economists reckon.
The Office for National Statistics data showed a rise in the unemployment rate, slowing wage growth and a huge 109K fall in the HMRC measure of payrolled employees.
The pound fell 0.5% versus the US dollar and 0.3% against the euro on Tuesday morning as the market interpreted the data as increasing chances of an August rate cut.
Deutsche Bank economist Sanjay Raja said the increase in labour market "slack" was expected, particularly after a more benign April inflation print.
"This will keep the MPC dialling down restrictive policy. But the UK labour market is not about to break – at least not yet," he said.
The May payroll data was the worst print we’ve seen since May 2020 and "paints a worrying picture", Raja added, "suggesting that firms may still be grappling with trade uncertainty and increased payroll costs".
Rob Wood at Pantheon Macroeconomics said it "could tip" the BoE's Monetary Policy Committee into cutting rates again in August.
The upward creep in the unemployment rate to 4.6% in April and a contrasting 98k rise in the Labour Force Survey's measure of employment "suggests a gradually rather than rapidly easing labour market," Wood felt, and means he takes the very weak payrolls data "with some caution".
Redundancies dropped to their lowest since before October’s Budget, "suggesting that firms are past the worst of the adjustments for higher payroll taxes", he added.
Raja agreed that it was "worth taking a step back", even if the number of payrolled employees has fallen in seven consecutive months, a cumulative drop of 276k and this morning's data was "a shocker".
As well as the Labour Force Survey painting a slightly different picture to the HMRC data, the HMRC figures "tend to get revised up as more data is collected" and he expects the 109k drop to be revised lower next month.
Raja said he expects the MPC to continue dialling down restrictive policy, predicting the base rate will be cut to 3.5% by the end of 2025 and drop to a 'terminal rate' of 3.25% in early 2026.
Hugh Lind, economist at CEBR, said while the drop in wage growth is "encouraging", it remains above the level consistent with the MPC inflation target.
"Taken alongside faster-than-expected growth in Q1 and a resurgence in inflation in April, we anticipate persistence in underlying inflationary pressures will prevent the BoE from easing too aggressively. We, therefore, expect just one more cut in the bank rate by the end of the year," he said.
Monica George Michail, associate economist at NIESR, said, "if wage inflation remains elevated in the coming months, there would be even less room for interest rate cuts by the Bank of England".
Thomas Pugh, economist at RSM UK, said that with private sector pay growth still running at almost double the rate the MPC is comfortable with, "further policy easing will be gradual. A rate cut next week still seems off the table, but today’s data makes it more likely that the next cut comes in August."
Taking all of the ingredients together, Pugh said: "The labour market is clearly cooling, and we are becoming more concerned about demand for labour.
"Indeed, rather than the labour market starting to recover in May, the early indications are that easing accelerated.
"The hawks on the MPC will still be too concerned about strong wage growth to consider going for another rate cut in June. But today’s data leaves the MPC on its gradual rate-cutting path."
He expects two more cuts this year, leaving rates at 3.75% by the end of the year.