Scottish Economy

Economic outlook improves but only from bad to fairly weak

Many of the signs in the economy have improved in recent weeks, confirming the recent view of leading economic forecasters that the UK economy is likely to escape a technical recession in 2023.

Earlier this month, the ONS published the first estimate of economic growth over the first quarter of 2023, which showed that the economy grew by 0.1% over this period. Weak growth, yes, but growth nonetheless. Interestingly, one of the main drags on growth during this first quarter was from the public sector, with public administration, health and education showing contractions as workers in these industries withdrew their labour in some parts of the UK.

Other signs are also positive, as we have seen recently in our own Scottish Business Monitor, produced in partnership with Addleshaw Goddard.

Towards the end of last year, 75% of firms surveyed expected growth in the Scottish economy over 2023 to be weak. This has since come down to just over 60%. An improvement, but still the case that the majority of firms expect poor growth over the next year.

On average, firms were much more optimistic in the first quarter of this year about their expected volume of business over the next six months compared to our last survey. Business sentiment in our latest monitor is at the highest level it has been since the end of 2021.

However, while there were positive sentiments around employment and turnover, there continues to be negative sentiment, on aggregate, when it comes to expected capital investment and expected export activity. It is important to note that the openness of our economy on the international stage and how much we invest are key productivity indicators. Continued underperformance of these drivers of growth could act as a brake on Scotland’s longer-term economic prosperity.

Energy cost pressures have waned, and this has been a contributing factor to this slight improvement in the short-term outlook.

The proportion of firms expecting to reduce their operations this year due to higher energy bills has come down from highs of 50% reported in the last quarter of 2022 to 39% in Q1 2023. However, half of hospitality firms expect to reduce their operation this year due to fuel costs.

When asked whether or not the UK Government’s Energy Bills Discount Scheme, which replaced the Energy Bills Relief Scheme on the 1st of April, will adequately support their business over the next financial year, just 8% of firms felt that it would, with 37% reporting that it would not. 60% of hospitality firms reported that the new scheme would not adequately support their business.

Supply chain issues also appear to be easing. Just under a third of Scottish firms reported that they found it difficult to purchase goods and services this quarter – down from 41% last quarter. However, firms citing prices as a driver of their supply chain issues has increased to 64%.

So, despite the fact that energy costs have calmed, the economy is now in a much higher price environment than last year, and even as inflation starts to come down, this does not mean prices will fall. A fall in the inflation rate, so long as it is still a positive number, means that the rate at which prices are rising is slowing.

A typical result following higher-than-usual inflation is higher-than-usual wage rises.

Our latest survey asked businesses what their main cost drivers have been over the last quarter and what effect they may have over the next six months. Since the cost-of-living crisis began, energy costs have been chief among business concerns however, this quarter, wages overtook energy as the most common current and expected cost pressure for firms.

These concerns about wage rises are being fuelled by the extremely tight labour market – that is, we remain in a situation where employment is near a record high, unemployment is near a record low, and although vacancies fell back a bit from the highs of last Summer, they remain at historically very high levels. This means that we have too few people chasing too many jobs: and in turn, this makes the bargaining position of employees stronger, which leads to strong wage growth.

So, while a good deal of the stubbornly high inflation is driven by food and energy prices, there are also sources of domestically generated inflation as the price of labour gets more expensive.

In response to this, the Bank of England raised interest rates for the 12th meeting in a row, taking the rate up to 4.5%. The Bank has done this to continue to bear down on this stubborn inflation, which has only just come down to single digits in the latest data – down from 10.1% in March to 8.7% in April.

To add to the positivity, the International Monetary Fund (IMF) has upgraded their forecasts of the UK economy since April, when they were forecasting a contraction of 0.3% this year. The IMF is now expecting growth in the UK economy of 0.4% in 2023.

The Bank of England’s outlook has also improved considerably since its last set of forecasts were published in February. Broadly in line with the Office for Budget Responsibility, they now think that the UK economy will overall be flat in the first half of 2023 before returning to growth in the second half of the year. The Bank are forecasting 0.4% growth in 2023, followed by 0.7% growth in 2024. It is worth highlighting, though, that the Bank’s figures for 2024 and beyond are pretty anaemic and well below the current forecasts from the OBR.

The Bank’s expectations were for inflation to fall sharply from April as the high price levels from a year ago come into comparison, and whilst the headline rate has come down from double digits, the latest estimate for April is slightly higher than the Bank’s forecast of 8.4%. On top of this, core inflation, often considered to be domestically driven inflation as it excludes foods and fuels, reached a 31-year high of 6.8%.

We will be watching closely to see if the Bank of England’s Monetary Policy Committee decides to raise rates for the 13th consecutive time when they meet for the next time on June 22nd.

This article was originally published in The Herald.


Adam is an Economist Fellow at the FAI who works closely with FAI partners and specialises in business analysis. Adam's research typically involves an assessment of business strategies and policies on economic, societal and environmental impacts. Adam also leads the FAI's quarterly Scottish Business Monitor.

Find out more about Adam.