In the 20 years since she set up her chain of coffee shops, the business climate has never felt as difficult as it does now, according to Helena Hudson, whose Real Eating Company has 10 outlets in market towns and cathedral cities across south-east England.
Even in prosperous areas, “people are still very much watching the pennies”, she said, leaving her little hope of offsetting a £127,000 rise in her tax bill in April through price rises alone. Nor can Hudson hold down wages, since a minimum-wage increase of 6.7 per cent will apply to many of her staff.
So she is cutting jobs: closing a café in London, making a long-standing manager redundant and asking part-timers to work longer hours or leave, since they will no longer fall below the threshold for employer national insurance contributions. “It’s not what we want to do,” Hudson said.
Businesses across the UK are making similarly uncomfortable choices as they calculate how best to respond to the tax and wage increases announced by Rachel Reeves in the October Budget.
The policies — which the chancellor said would help restore “stability to the public finances” and pay for public services — will sharply increase labour costs, particularly in low-wage sectors such as retail and hospitality.
The question the Bank of England must answer is whether a weaker jobs market will finally bring down wage growth — or whether stubborn pay pressures will persist, keeping inflation above the official 2 per cent target.
There is mounting evidence that employers have cut headcount in the wake of the Budget announcements, with official data showing payroll employment fell in November and December as vacancies kept sliding.
Survey data published on Friday suggested the share of businesses cutting staffing levels was higher in January than at any point since the 2008-09 financial crisis, except the pandemic period.
Liz Martins, economist at HSBC, said the combination of a weaker economy, higher costs and new scope for artificial intelligence-related efficiencies felt “like a perfect storm” for the jobs market.
Last week, retailer J Sainsbury said it was axing 3,000 jobs, from its head office to its in-store cafés, while an executive at Associated British Foods, owner of the low-cost fashion chain Primark, said people were starting to buy fewer clothes because of worries about job security.
But despite such retrenchment, wage growth has accelerated. Data last week showed private sector earnings grew at an annual pace of 6 per cent in the three months to November, excluding bonuses — double the 3 per cent pace the BoE thinks broadly consistent with the inflation target.
One contributing factor, highlighted in a recent trading statement by retailer Next, is that increases in the minimum wage have a lasting “ripple” effect on pay higher up the scale, as employers seek to maintain incentives for promotion to higher grades.
Andrew Wishart, economist at Berenberg bank, described this situation as a “massive headache” for the BoE’s Monetary Policy Committee, which is expected to cut interest rates from 4.75 per cent to 4.5 per cent when it next meets on February 6.
He said the minimum wage was “becoming a serious problem” because it prevented low-wage employers absorbing the £25bn NICs increase by holding down pay.
Yet even as they shed jobs, other businesses would still be able to pass on higher costs to consumers, keeping services price inflation above 4 per cent and pushing headline inflation above 3 per cent later this year.
The BoE, which watches services inflation closely, was still likely to lower interest rates in the short term in order to prevent a “horrible” outcome for workers, but it might need to stop cutting the cost of borrowing in the second half of the year, Wishart said.
Other economists believe wage growth will slow over the course of the year, as companies will no longer fight to recruit higher-paid professionals who cannot wring a salary rise out of their current employer.
Martins of HSBC said that trend was “in the past now”. While April’s changes might lead some companies to raise prices initially, she argued that all the other ways they might respond — replacing workers with AI, squeezing pay, cutting jobs or offshoring work — would eventually lower inflation.
But wage growth may not subside fast enough for the BoE’s comfort.
Four-fifths of employers planned to make lower pay awards this year than in 2024, according to a poll conducted by analysts at Incomes Data Research and published on Monday. Most said the increase in NICs would make them less generous than they otherwise would have been.
But the survey found that more than half of employers who had not yet decided their award expected it to exceed 3 per cent. Where pay deals had been agreed, over 40 per cent of employees were receiving 4 per cent or more.
“All business surveys illustrate the same conundrum for the MPC. Payroll tax hikes, global uncertainty and tariff threats are driving inflation and output in opposite directions,” said Elliott Jordan-Doak, senior UK economist at the consultancy Pantheon Macroeconomics.
This meant that even with growth weak enough to warrant rate cuts, inflation remained strong enough to require caution, he added, noting that tax increases were affecting both jobs and prices more than rate-setters had expected, with little effect on wages.
If this remains the case, unemployment may need to rise further than previously thought for the BoE to keep inflation down.
“Wage growth will take a little longer to come down than the BoE might like,” Martins said, “but we think that remaining pressures are being driven by government policy, not a tighter labour market.”
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