(Alliance News) - The UK labour market delivered an unexpected boost in early 2026, with unemployment falling more sharply than forecast, but economists warn the headline improvement may be misleading and could reverse in the months ahead.

Data from the Office for National Statistics showed the jobless rate declined to 4.9% in the three months to February from 5.2%, surprising analysts who had expected no change. At first glance, the drop suggested a stabilising jobs market after a challenging end to 2025.

Economists at ING said the fall in unemployment "appears to be driven by a spike in 'economic inactivity' as opposed to a rise in employment."

"The unemployment rate dropped from 5.2% to 4.9%. But crucially, this does not appear to be because of a big shift into work," ING said. "Employment was little changed over the past quarter. Instead, the details reveal the drop in the jobless rate is pretty much solely down to a rise in 'economic inactivity' – that is, people neither in work nor actively seeking it."

The Office for National Statistics noted that the rise in inactivity was particularly visible among students, suggesting fewer people were actively participating in the labour market.

ING cautioned that "the bottom line is the drop in unemployment isn't necessarily the 'good news' story it first seems."

That view is reinforced by payroll data, which continues to signal weakness in hiring. ING said "private sector employment continues to drop, driven primarily by consumer services," with employee numbers in those sectors falling at an annualised rate of 1.6%.

Consumer-facing industries such as retail and hospitality have been under particular pressure, reflecting both weaker demand and rising cost burdens for employers.

At least part of this weakness stems from policy changes introduced last year, including higher employer National Insurance contributions and increases to the minimum wage.

"These policy changes… have had a much more tangible impact on employment than inflation," ING said, warning that similar pressures could intensify as energy prices rise again.

Indeed, the broader macroeconomic backdrop has shifted significantly since the data period ended in February. Rising oil prices and supply disruptions linked to geopolitical tensions are expected to push inflation higher and weigh on corporate hiring decisions.

Danni Hewson, head of financial analysis at AJ Bell, said the figures reflected a labour market that had shown "signs of recovery before Iran war."

"Unemployment fell back from its five-year high in the three months to February, but it's impossible to know whether this was a real turning point for the UK economy or simply a post-Budget boost," Hewson said.

She added that "the Iran war has changed the playing field and the associated energy price shock and fears over supply issues are set to rekindle inflation and push companies to rethink their hiring intentions and potentially cut staff."

That, she warned, is likely to reverse the recent improvement, with unemployment "expected to push… back up, potentially peaking around 5.8%."

Even before these new pressures emerged, signs of softness were evident beneath the headline data. Hewson noted that "if you look under the bonnet the weakness in the labour market hadn't really gone away."

Hiring remained subdued, and there are indications that fewer young people are actively seeking work, possibly reflecting limited opportunities.

Vacancies have also declined, falling to their lowest level since April 2021, according to AJ Bell, underscoring a cooling jobs market.

At the same time, wage growth - a key metric for policymakers - has continued to moderate. While earnings still rose faster than expected, the pace of growth has slowed compared to previous quarters.

ING highlighted that "private sector pay growth dipped to 3.2% in the most recent data, which… is consistent with a 2% inflation target."

However, with headline inflation expected to rise towards 4% later this year, real wages are likely to come under renewed pressure.

"With headline inflation poised to rise towards 4% in Q3, it suggests real wages are set to fall and pressure on economic growth will mount," ING said.

Analysts at Deutsche Bank also questioned the strength of the labour market, arguing the drop in unemployment does not alter the broader narrative of weakness.

"We've had several questions regarding the drop in jobless rate to 4.9%," Deutsche Bank said. "This was a massive surprise… but today's labour market story doesn't change the weak labour market narrative."

The bank pointed to a sharp decline in participation, with around 71,000 fewer people active in the labour market over the three-month period, which largely explains the fall in unemployment.

At the same time, employment dynamics have shifted in ways that may not signal underlying strength.

"If we look at the number of employees… there was a 63,000 drop," Deutsche Bank said, adding that "the number of self-employed rose by a whopping 81,000," marking the second-largest increase on record.

This suggests the labour market may be adjusting through a rise in self-employment rather than robust hiring by companies.

"Something else is going on," Deutsche Bank said, concluding that "underlying weakness persists. There is still slack in the labour market."

Looking ahead, economists broadly expect conditions to deteriorate rather than improve, particularly as businesses face rising costs and uncertain demand.

ING said the UK jobs market is entering the current energy shock "in a fragile state – and crucially, much weaker than it was… at the onset of the last oil/natural gas shock."

This fragility is likely to influence monetary policy. While inflation risks remain elevated, the weakening labour market reduces the case for tighter policy.

"That is not a backdrop that is conducive to a renewed spike in wage growth," ING said, adding: "For the time being, we think the [Bank of England] will opt against rate hikes this year."

AJ Bell's Hewson similarly expects policymakers to remain cautious, noting that the Bank of England's Monetary Policy Committee is likely to "hold fire" as it assesses the impact of rising prices and geopolitical developments.

By Eva Castanedo, Alliance News reporter

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