Britain’s private sector workforce is staring down its sharpest squeeze on real take-home pay since the cost-of-living crisis of 2022, as a fresh burst of oil-driven inflation outpaces a visibly slowing rate of earnings growth.
Figures released by the Office for National Statistics this week show that average weekly earnings excluding bonuses rose by 3.4 per cent in the three months to March, exactly matching the average rate of inflation over the quarter. Including bonuses, the figure climbed to 4.1 per cent, although that headline number was almost certainly flattered by outsized payouts in the City’s financial services sector.
For the rank-and-file employee outside the public payroll, the picture looks considerably bleaker. Real incomes are on course to flatline through 2026, with the surge in global crude prices expected to drag annual CPI back up towards 4 per cent in the coming months. With unemployment now at 5 per cent and youth joblessness at an 11-year high, the bargaining power that working households briefly enjoyed during the post-pandemic labour shortage has all but evaporated.
“There is potential for a sharp squeeze in real wage growth in 2026,” said Peter Dixon, senior economist at the National Institute of Economic and Social Research.
A broad-based slowdown
Wage growth has weakened across nearly every sector of the economy, with construction wages actually contracting outright by 0.6 per cent between January and March. Builders have been hit on three sides at once, energy, transport and raw materials, since the US-Iran conflict triggered a fresh spike in oil and shipping costs.
Private sector earnings growth has slipped to 3 per cent, the slowest pace since the pandemic. Analysts at ING calculate that the rolling three-month measure of private sector pay grew by just 0.6 per cent, its weakest reading in more than a decade.
The contrast with Whitehall is stark. Public sector pay rose by 4.8 per cent over the same period, buoyed by the increase in the national living wage and by generous settlements recommended by the independent pay review bodies under the Labour government. The growing divide has reignited a long-running political row with employers warning that the gap is becoming politically and economically untenable.
A new period of falling real wages
The Resolution Foundation is unambiguous about what the figures mean for household finances. The think-tank’s latest analysis warns that Britain is on the brink of its fourth period of falling real wages in less than two decades, a record unmatched by any other advanced G7 economy.
“The UK is on the cusp of its fourth period of falling real-wage growth in less than two decades,” said Julia Diniz, economist at the Resolution Foundation. “This stuttering performance goes a long way in explaining the political and economic discontent that surrounds modern Britain.”
For lower-income households, that discontent is more than rhetorical. Edward Allenby, senior economist at Oxford Economics, warned that the inflation about to hit family budgets will be concentrated in the categories that bite hardest at the bottom of the income distribution.
“Higher inflation will likely be concentrated in essential categories, food, energy, petrol, that comprise much larger shares of lower-income household spending,” Allenby said. “These households also appear to be entering the latest energy shock in a more vulnerable financial position than the last one.”
The Bank’s dilemma
The Bank of England is now caught in an uncomfortable bind. Threadneedle Street has kept Bank Rate pegged at 3.75 per cent since the Middle East conflict broke out, but the Monetary Policy Committee has already signalled that it may have to resume tightening to head off so-called “second-round effects”, the risk that companies pass higher energy costs through to prices, and workers in turn demand inflation-busting settlements.
The wage figures suggest the second of those channels is closed for the moment. The Bank has previously indicated that it needs average earnings growth in the region of 2 to 3 per cent to hit its 2 per cent inflation target, a benchmark the latest data are converging on rapidly. The prospect of rate rises in the middle of an energy-driven inflation spike risks compounding the squeeze on households already feeling the pinch.
“A soft labour market could limit arguments that there will be notable second-round effects from the current energy shock,” said Josie Anderson, economist at Nomura.
Markets had been pricing in close to three quarter-point increases this year, taking the base rate back to 4.5 per cent, before Tuesday morning’s labour market release. That bet now looks aggressive. Andrew Wishart, economist at Berenberg, said the MPC would be “wary of pushing the labour market over a tipping point that triggers recessionary dynamics”.
“The market still prices three hikes today but the labour market is too weak to bear them,” Wishart added. “Even if energy prices remain high, we suspect that the Bank will deliver one quarter-point hike at most.”
Market reaction
Investors agreed. Yields on two-year gilts, which track expectations of the Bank Rate over the policy horizon, fell by 0.02 percentage points on the repricing, bond yields move inversely to prices. Sterling weakened against the dollar and the euro as traders trimmed their bets on UK interest rates.
For Britain’s small and medium-sized businesses, the takeaway is mixed. A pause in the Bank’s tightening cycle would offer welcome relief on borrowing costs at a moment when many SMEs are still digesting the rise in employer National Insurance contributions and the higher national living wage. But the wider story, flat real incomes, rising unemployment and cooling consumer demand, points to a more difficult trading environment through the second half of 2026, particularly for businesses with discretionary, consumer-facing revenue streams.
Whether the squeeze ultimately delivers the political backlash that the Resolution Foundation’s analysis implies remains to be seen. What is no longer in doubt is that, for the fourth time in less than 20 years, the average British worker is becoming poorer in real terms, and SME owners hoping for a confident consumer to spend their way through the next 12 months should plan accordingly.
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Private sector workers face worst real pay squeeze since 2022 as oil-driven inflation bites