Unemployment rate scenarios

Unemployment was higher than expected, but its cause – and therefore how likely it was to persist – was uncertain. In this box, we explored alternative scenarios in which the recent rise in unemployment proved to be either cyclical or structural, illustrating the potential implications for GDP, wages and inflation.

This box is based on ONS and OBR data from .

In the central forecast, we judge that the recent uptick in unemployment is likely due to cyclical factors but there is uncertainty around the persistence of this weakness. There is also some evidence which points to the possibility of some of the rise in unemployment being structural. It is not yet clear what the impact will be on the labour market of new technologies such as AI and higher labour costs from policies such as the rise in employer National Insurance contributions.a As discussed in Box 2.3, growth in real wages has recently outpaced growth in productivity which could induce firms to maintain a lower level of employment to cover these higher labour costs. Given these uncertainties, in this box we explore four alternative scenarios for the unemployment rate.b The fiscal impact of these scenarios is discussed in Chapter 6.

The first two scenarios continue to assume the recent rise in unemployment is cyclical, as in the central forecast, but with different assumptions for the timing and level of the peak:

  • In our cyclical upside scenario, the unemployment rate falls more sharply from 5 per cent in 2025-26 to its estimated equilibrium rate of 4.1 per cent by 2027-28, two years earlier than in the central forecast. Compared to the central forecast, GDP growth is higher in the near term (by 0.7 percentage points in 2026-27) but its level is unchanged at the forecast horizon. The tighter near-term labour market results in stronger nominal wage growth, which averages 0.7 percentage points above the central forecast at 3.2 per cent between 2026-27 and 2028-29. With less spare capacity and stronger wage growth, inflation and interest rates are both temporarily slightly higher than the central forecast.
  • In our cyclical downside scenario, we assume the unemployment rate peaks at 6.8 per cent in 2026-27, 1.5 percentage points above the central forecast. It then falls sharply to 4.1 per cent by 2030-31. In this scenario, GDP growth is negative in 2026-27 (1.6 percentage points below our central forecast) but its level is unchanged in 2030-31. The looser labour market leads to weaker wage growth, which averages 2 per cent between 2026-27 and 2028-29, 0.5 percentage points below the central forecast. This results in a lower labour share of income and lower consumption share of expenditure in the near term. Inflation and interest rates are both temporarily lower than the central forecast.

The second two scenarios both assume a structural – and so more persistent – increase in the unemployment rate, with the equilibrium rate rising to 5.5 per cent in both. We vary the drivers of this increase, and therefore what happens to trend productivity and the labour share, to show the different implications for real GDP and the fiscal position:

  • In our ‘technological displacement’ scenario, new technology displaces workers and is a substitute for labour, increasing capital deepening and raising productivity for workers who remain employed. We assume that this higher trend productivity fully offsets lower employment to leave the level of GDP unchanged but that this increase in average labour productivity is not reflected in higher real earnings. This implies a lower labour share and a higher corporate profit share relative to our central forecast. As labour income faces a higher effective tax rate, this reduces the tax-richness of economic activity.
  • In our ‘higher labour costs’ scenario, the reduction in employment reflects a higher cost of employment and is not offset by higher productivity. This implies a lower level of real GDP relative to our central forecast, but unchanged labour and corporate profit shares.

Chart B: Unemployment scenarios

Four line charts showing the unemployment rate and level of real GDP associated with the different scenarios.

Source: ONS, OBR

This box was originally published in Economic and fiscal outlook – March 2026

a) For example, in our central forecast, we assume that the recent rise in employer NICs increases employer payroll costs by just under 2 per cent. More detail can be found in Chapter 3 of the October 2024 EFO. We consider the effects from AI specifically on productivity to be highly uncertain and present our central assumptions alongside alternative scenarios in Annex B of Briefing paper No.9: Forecasting productivity, November 2025.
b) While in this box we only look at scenarios for unemployment, in practice, it is likely that higher structural unemployment may also be associated with higher economic inactivity. The fiscal implications of higher (or lower) health-related inactivity were explored in detail in our July 2023 Fiscal risks and sustainability report.