Unemployment is expected to reach its highest level in five years in the first half of the year, according to a new forecast.
The unemployment rate rose to 5.1 per cent in November following only modest GDP growth and a hike in business costs.
It is expected to peak at 5.2 per cent in the first half of this year due to a ‘slowdown in economic momentum and a reduction in public sector headcount,’ said EY Item Club.
EY Item Club forecasts the unemployment rate will fall back to 4.7 per cent by 2028.
Wage growth is expected to slow to around 3 per cent as the increase in employer National Insurance Contributions (NICs) feeds through to the wider economy.
This, alongside rising unemployment and frozen income tax thresholds, is forecast to slow real income growth from 1 per cent to 0.8 per cent this year.
The unemployment rate is expected to peak at 5.2% this year amid higher business costs
It comes as a survey by wealth manager Rathbones revealed that one in five small businesses laid off staff last year amid higher costs.
Some 58 per cent of SMEs said rising costs, including business rates and NICs, contributed to redundancies.
Last week, Begbies Traynor warned that tens of thousands of firms are on the verge of collapse, with the number of companies in ‘critical financial distress’ reaching 67,369 in the last quarter of 2025.
Elsewhere, the Item Club expects subdued GDP growth over 2026 as tax hikes and spending cuts affect the economy.
GDP growth is expected to pull back to 0.9 per cent this year, a slowdown from the forecasted 1.4 per cent for 2025.
As firms come under pressure, private sector investment is expected to shrink by 0.2 per cent.
Matt Swannell, chief economic advisor to the EY Item Club said: ‘The Autumn Budget saw the Government build a healthier degree of fiscal headroom, although some of the more substantial measures won’t take effect for a couple years.
‘In the meantime, further tax rises may not be expected in 2026, but previously announced measures will begin to raise revenues, while the government will need to reduce borrowing and keep public spending steady in order to meet its fiscal rules.
This tightening of fiscal policy, alongside ongoing global uncertainty, is expected to drag on UK growth over the next year or so.’
It comes ahead of the Bank of England’s next interest rate decision on Thursday, when it is widely expected to keep the base rate at 3.75 per cent.
EY expects one further rate cut this year in April as inflation eases to the 2 per cent target by the middle of the year.
Swannell said: ‘Easing inflation and falling interest rates should improve consumer sentiment, but this will be countered by slowing pay growth and rising unemployment levels.
‘Nonetheless, the current confidence gap between high and low earners is unusually wide and, as households on greater pay start to feel more upbeat, we can expect slowing real income to be cushioned by a reduced focus on saving.
‘This should support continued consumer spending growth this year and next, albeit at a modest level.’
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