British assets were volatile on Tuesday as weaker-than-expected labor market data rattled investor sentiment ahead of two pivotal policy events  the Autumn Budget and the Bank of England’s final interest rate decision of the year. With unemployment rising faster than anticipated, traders ramped up bets that policymakers could deliver a rate cut by Christmas to cushion the slowing economy.

Data from the Office for National Statistics (ONS) showed the U.K.’s unemployment rate climbed to 5% in the three months to September, surpassing expectations of 4.9%. Meanwhile, the number of payrolled employees dropped by 32,000 between August and September, signaling that hiring momentum has weakened just as fiscal tightening looms.

By late morning in London, 10-year gilt yields fell more than 5 basis points to 4.405%, while the British pound slid 0.3% against the dollar and 0.4% versus the euro. The shift reflects growing conviction that the Bank of England (BoE) will pivot toward rate cuts sooner than anticipated a move that could define the trajectory of U.K. markets heading into 2026.

Labor Market Softness Raises Rate-Cut Expectations

The latest ONS report underscores the delicate balance the BoE faces: inflation remains stubbornly above target, yet economic data point to a rapid cooling in employment and wage growth.

“Labour market slack continued to widen  even surprising market expectations,” said Sanjay Raja, chief U.K. economist at Deutsche Bank. “While budget uncertainty may be hampering hiring plans heading into Q4, today’s data should strengthen the case for a Christmas rate cut.”

According to LSEG data, traders now see a 75% probability of a rate cut in December, reflecting confidence that monetary easing could arrive sooner than the BoE’s own forward guidance implied.

Deutsche Bank’s projections had anticipated a rise to 4.9% unemployment, aligning closely with the BoE’s November outlook. Tuesday’s reading  slightly above that  suggests more slack building in the labor market than policymakers assumed. Raja said the latest data “gives the majority of the MPC added confidence that weakness in the labour market is translating into weaker pay momentum, which should ultimately feed through into inflation in the months and quarters to come.”

Grant Slade, economist at Morningstar, echoed that sentiment, saying the disinflationary trend “is still alive and well.” He expects further rate normalization through 2026, noting that the U.K. remains “on a slow path back to monetary balance.”

Fiscal Policy Dilemma: Pressure Mounts on Rachel Reeves

The worsening jobs data also adds pressure on Finance Minister Rachel Reeves, who is preparing to deliver her Autumn Budget on November 26. Analysts say the fragile labor market limits Reeves’s fiscal flexibility just as she faces calls to raise revenue without choking growth.

“Today’s unemployment numbers increase the pressure on both the government and the Bank of England to change course  go easy on tax rises and cut rates respectively,” said Julian Howard, chief multi-asset strategist at GAM Investments. “But neither is straightforward. The government somehow has to fix the dire fiscal position without strangling animal spirits.”

Reeves’s fiscal framework  which mandates that day-to-day spending be funded by tax revenues and that public debt must fall as a share of GDP by 2029  has boxed her into limited options. With borrowing off the table, Reeves is exploring new tax measures, including higher dividend levies and targeted increases on investment income.

Yet such measures risk further weakening consumption. “Income tax, pensions, ISAs, housing  all are in scope,” Howard cautioned. “But squeezing these will have a dampening effect on consumption and enterprise to varying degrees.”

The political risk is equally high. Breaking a manifesto pledge not to raise taxes on working people could erode confidence among voters, while failing to stabilize the public finances may unsettle markets already jittery about the U.K.’s fiscal credibility.

Markets Eye Coordination Between BoE and Treasury

With U.K. inflation cooling to 3.8% in October  still nearly double the BoE’s 2% target  monetary policy remains in a tightening bias. However, the combination of rising unemployment, falling real wages, and slowing consumer demand strengthens the argument for an early policy pivot.

Investors are watching for signs of coordination between the BoE and the Treasury, as simultaneous policy tightening on both fronts could deepen the downturn. “The fragility of the labor market underscores how little margin for error policymakers have,” said Paul Dales, chief U.K. economist at Capital Economics. “If fiscal consolidation coincides with premature monetary restraint, the economy could stall heading into 2026.”

Markets are also wary of fiscal credibility risks, particularly after the bond turmoil following the 2022 mini-budget. The sharp decline in gilt yields on Tuesday suggests that investors are positioning for a policy softening rather than a repeat of fiscal brinkmanship.

Outlook: Fragile Recovery, Narrow Options

The U.K. economy now sits at a critical crossroads. While disinflation has created space for monetary easing, weak labor data and limited fiscal maneuvering threaten to undermine growth. For investors, this creates an environment of heightened volatility but emerging opportunity  especially in rate-sensitive assets like gilts and mortgage-backed securities.

The coming weeks will test the BoE’s willingness to act preemptively and the Treasury’s ability to maintain fiscal credibility under political pressure. If policymakers can calibrate a soft landing, Britain may exit 2025 with inflation anchored and growth stabilizing. But any misstep either a delayed rate cut or excessive fiscal tightening could risk tipping the U.K. into a deeper, self-inflicted slowdown.