UK unemployment set to hit five-year high as tax rises begin to bite, EY warns

UK unemployment is expected to rise to its highest level in five years in 2026 as previously announced tax increases begin to weigh on growth and hiring, according to new forecasts from the EY Item Club.

The forecasters warned that joblessness could peak at 5.2 per cent in the first half of this year, up from the current 5.1 per cent and the highest level since January 2021, as modest economic growth is constrained by tighter fiscal policy and global uncertainty.

The EY Item Club said tax rises announced by Rachel Reeves in her first Budget are set to have a more pronounced impact this year, dampening both consumer spending and business investment. Employers were already hit by a £25 billion increase in national insurance contributions last spring, a move that business groups have warned would curb hiring.

Matt Swannell, chief economic adviser to the EY Item Club, said the effects of fiscal tightening are only now starting to filter through the economy.

“Further tax rises may not be expected in 2026, but previously announced measures will begin to raise revenues,” he said. “At the same time, the government will need to rein in borrowing and keep public spending broadly flat 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.”

Economic growth is forecast to remain subdued. The EY Item Club now expects UK GDP to grow by 0.9 per cent this year — slightly higher than its previous estimate of 0.8 per cent, but still weaker than in 2025. Growth is then projected to recover modestly to 1.3 per cent in 2027 and 1.4 per cent in 2028.

Reeves announced a further £26 billion of tax increases in last November’s Budget, although, as with her earlier package, many of those measures will not take effect for several years. Even so, the cumulative impact of higher taxes is expected to weigh on confidence.

The EY Item Club said global risks remain a major headwind. Trade tensions and tariff disruption, particularly linked to the policies of Donald Trump, are expected to continue undermining private sector sentiment.

Financial markets were unsettled in January after Trump tested Nato alliances and announced plans to nominate Kevin Warsh as the next chair of the Federal Reserve, adding volatility to currency and commodities markets. Concerns have also lingered around inflation and public spending commitments in major economies, including Japan.

On monetary policy, the EY Item Club expects the Bank of England to hold interest rates steady at its meeting this week, before cutting again in April. Rates were reduced four times last year, falling from 4.75 per cent to 3.75 per cent.

Despite slower growth and rising unemployment, pay growth is expected to remain relatively resilient. The EY Item Club forecasts average salaries will rise by around 3 per cent this year, though that will translate into only modest improvements in living standards as higher taxes and prices continue to erode household incomes.

The outlook suggests that while a deep recession is not expected, the UK faces a period of weaker growth and rising labour market pressure as fiscal tightening and global uncertainty converge.

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UK unemployment set to hit five-year high as tax rises begin to bite, EY warns