Britain's Narrow Path: The August labour report, the Ofgem effect and a bank that cannot cut

The United Kingdom has arrived at the least forgiving combination available to a central bank. The labour market is shedding jobs on almost every measure that can be trusted. Inflation has stopped falling and turned back up. And the gilt market has made it clear it will not fund a fiscal response. This is not stagflation in the 1970s sense where nominal wage growth is decelerating and services inflation is still coming down, but it is a version of the same trap, and it explains why three of the nine members of the Monetary Policy Committee voted to raise Bank Rate at the end of July while the rest voted to hold. In this article I want to work through the August labour market release and the July inflation print together, because neither makes sense in isolation.

The Jobs Data: Two surveys, one conclusion

The ONS released its labour market overview on 18th August, covering the April to June quarter. The headline unemployment rate for those aged 16 and over was 4.9%, up 0.2 percentage points on the year but down 0.1 on the quarter, with 1.77 million people unemployed. Unemployment has risen by 88,000 over the year, from a rate of 4.7%.

The complication is that the Labour Force Survey, which produces that headline, is currently the least reliable instrument in the ONS toolkit. A data collection error in May and June compounded the sampling problems that have dogged the survey since 2023, and the ONS has explicitly told users to read its estimates alongside other sources rather than in place of them. This matters here, because the LFS says employment rose by 250,000 over the year to April-June, and the administrative data says close to the opposite.

The PAYE Real Time Information series, which counts actual payrolled employees rather than surveying households, shows employment falling. Payrolled employees fell by 78,000 (0.3%) between June 2025 and June 2026. On the April to June basis comparable with the LFS, they were down 86,000 on the year and 37,000 on the quarter. The early July estimate showed 30.3 million payrolled employees, down 94,000 on the year.

When a household survey with known collection problems says employment is up a quarter of a million and a near-census of employer tax records says it is down by nearly 90,000, the tax records win. The employment rate for those aged 16 to 64 came in at 75.1%, down from 75.3% a year earlier, while economic inactivity sat at 20.9%, or 9.11 million people, up 55,000 on the year. The direction of travel is a labour market that is losing jobs and losing participants at the same time.

Vacancies, Redundancies and the Quits Signal

Vacancies fell again to 707,000 in the three months to July. That is below pre-pandemic levels and the lowest reading since late 2014. The demand side of the labour market has been contracting for over two years now, and smaller businesses have been consistently explicit that higher employment costs are the reason they are not hiring.

There are two genuine offsets, and I think they are underweighted in most of the commentary. The claimant count fell to 1.665 million in July from 1.689 million in June, taking the claimant rate down to 4.3%, with both figures below year-ago levels. Redundancies fell to their lowest level since July 2025. And the quits rate which is the share of workers voluntarily leaving jobs has been rising. Quits are a confidence indicator: people only resign when they believe they can find something better, and a rising quits rate has historically been a leading signal of stabilisation well before headline hiring recovers.

So, the picture is not one of collapse. It is one of a market that has stopped hiring rather than started firing. Firms are shrinking through attrition and through not replacing leavers, which produces exactly this signature of falling payrolls, falling vacancies, falling redundancies, rising inactivity.

Pay: The number the bank actually watches

For the MPC, the decisive series is private sector regular pay, and it is finally behaving. In the three months to June, average weekly earnings including bonuses rose 4.1% in nominal terms and regular pay excluding bonuses rose 3.5%. Private sector wage growth is now running at its slowest pace since 2020.

In real terms, workers are still marginally ahead: total pay grew 1.3% and regular pay 0.7% after inflation. But the trajectory is what matters. The Bank forecast in February that private sector wage growth would reach 3.3% by Q4 2026, and the June data is tracking that path closely. The OBR's March forecast had nominal average hourly earnings growth at 3.4% for 2026 falling to 2.4% in 2027. If pay settlements continue to decelerate on this trajectory, the domestic inflation generator that has kept UK services inflation above every comparable economy since 2022 is finally switching off.

That is the doves' entire case, and on the labour data alone it is a strong one.

The Inflation Problem is an Energy Problem

Then came the 19th of August CPI release, and it complicated everything. Headline CPI rose to 2.9% in the year to July, up from 2.6% and the highest reading in four months. It was the first increase since March, interrupting a run that had taken inflation from 3.3% in March down to a 15-month low. The print landed exactly on consensus, which is why sterling barely moved, up around 0.1% against the dollar on the day.

The composition is what matters. The largest upward contribution came from housing and household services, which jumped to 4.1% from 2.7%, reflecting the 13% increase in Ofgem's energy price cap that took effect in July. Gas prices rose 14.7% on the month, the largest jump since October 2022, and electricity rose 3.6%.

Underneath that, the domestically generated components were fine or improving. Services inflation which is the Bank's preferred gauge of home-grown price pressure fell to 3.4% from 3.6% and is down from 4.4% in January against a 2023 peak of 7.4%. Core CPI held at 2.6%, marginally above the 2.5% expected but unchanged on the month. Food inflation eased to 1.3%, the lowest since September 2021, and transport decelerated sharply to 3.6% from 5.7%.

This is the crux of the Bank's problem. The inflation that is rising is imported energy, over which monetary policy has no influence whatsoever, arriving through an administered price cap. The inflation the Bank can control is falling. Raising Bank Rate does not lower the Ofgem cap; it lowers employment. The hawkish case which was made most clearly by Catherine Mann is not that rate rises will fix energy prices, but that with inflation having run above target for five years, near-term expectations are close to the threshold at which second-round effects become self-sustaining, and the collapse of the US-Iran memorandum has made the energy path meaningfully more volatile.

The Bank held Bank Rate at 3.75% on 30th July by six votes to three, with the minority pushing for an immediate move to 4.0%. Governor Bailey warned that energy prices would remain high and volatile and that inflation would rise again before year-end. The Bank's own projection has CPI peaking a little above 3.2% in Q4, and July's reading is tracking that forecast. A second Ofgem cap increase is expected in October.

The Gilt Market Will Not Wait

The constraint that ties all this together sits in the bond market. Thirty-year gilt yields have reached roughly 5.75%, the highest since 1998, and ten-year gilts are back above 5%. That move accelerated after the change of government in July, when Prime Minister Burnham signalled greater fiscal flexibility, and it reflects the same global term-premium dynamic pushing US thirty-year yields to nineteen-year highs.

The practical effect is that fiscal policy cannot substitute for monetary policy here. Any attempt to support a weakening labour market through spending will be met by a higher cost of funding it, and the Chancellor's headroom is measured against gilt yields that keep moving against her. The autumn Budget on 26th November is where that gets tested.

Overview

The Bank of England is being asked to set one policy rate against two problems moving in opposite directions. The labour market says cut: payrolls falling on the reliable measures, vacancies at a twelve-year low, participation deteriorating and private sector pay growth at a six-year low. Headline inflation says do not, and a hawkish third of the committee is arguing that five years above target has eroded the credibility that would let them look through an energy shock.

My reading is that the September decision comes down to whether the MPC treats the Ofgem effect as a level shift or a persistence risk. The composition of the July print supports the first interpretation which is energy up, services and food down. The wage data supports it strongly. But the committee has been burned by looking through supply shocks before, and the three dissenters are unlikely to be talked round by a print that landed on consensus.

The immediate dates are 16th September for August CPI, 17th September for the MPC decision and minutes, the October Ofgem cap announcement, and the Budget on 26th November. My base case is a hold in September with the split intact, and the more interesting question is what happens if the October cap rise pushes headline inflation through 3.25% while payrolled employment is still falling. That is the point at which the Bank must decide, explicitly and publicly, which half of its mandate it is prepared to miss.