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Scottish Economy, UK Economy

Weekly update: Sentiment goes down as interest rates go up

There’s been another busy week of economic and fiscal news to cover. The main headline is of course that the Bank of England Monetary Policy Committee (MPC) decided to raise interest rates for the eighth successive time, to 3%.

Also grabbing the headlines was the forecast that, if interest rates follow market expectations and go up to 5.25% by Q3 2023, the economy is likely to contract for 2 years, only returning to growth in Q3 2024.

The Governor of the Bank, Andrew Bailey, made clear that it was possible that the markets has over done the likely pathway for rates, implying that they may not end up getting above 5%. But, as the chart below shows, their view is that the economy is in for a rough time over the next 2-3 years, whatever the specific pathway for rates. Whatever happens, their expectation is that we will not be above pre-pandemic levels of output by the end of 2025.

Chart: Outlook for UK GDP Growth, 2019 Q4=100

Source: BoE

On Wednesday, we published our latest Scottish Business Monitor, covering Q3 2022, which showed that business sentiment is now in negative territory for the first since the end of 2020.

Chart: Net balance (%) of firms expecting an increase in their volume of business over the next six months, Q1 1998 – Q3 2022

Source: SBM

*Net balance of firms is defined as the share of firms reporting higher minus the share of firms reporting lower

With the price of goods, energy, and borrowing on the rise, the majority of Scottish firms that we surveyed are expecting to wind down their operations or pass on costs to their consumers over the next year.

However, there is some good news from our latest survey. Supply chain issues continue to ease, which may dampen inflationary pressures, and the ongoing energy crisis has motivated Scottish businesses to consider making energy-efficient improvements to their processes.

Additionally, In the most recent quarter, half of responding businesses reported that they had vacancies to hire new members of staff, down from 56% reported in the previous quarter.

Of those firms with vacancies, 90% were finding them difficult to fill – up 3 percentage points since the last survey. A lack of skills and applications continue to be the main barriers to filling job posts, and, increasingly, wage expectations are making it difficult for Scottish firms to hire the staff that they need.

Unsurprisingly, Scottish firms expect energy bills and wages to be their main cost pressures in the coming 6 months.

Scottish Economy contracts in August

Somewhat lost in the other news on Wednesday (see below) was new GDP data from the Scottish Government for August.

This showed that GDP fell by 0.3% in August, taking the Scottish economy below pre-pandemic levels of output – very consistent with the messages we saw from the Bank about a likely contraction overall in Q3.

The contraction was driven mainly by a fall in services output. In a sign of things to come, consumer facing services fell by 2.4%, chiming with what we are hearing from businesses.

Scottish Government cuts health funding to fund pay deals

On Wednesday, we had the Scottish Government’s Emergency Budget Review. We gave our initial reactions here, and the coverage since the publication on Wednesday has focussed very much on the cuts made to health spending to fund pay deals for health workers.

What is clear is that this may not be the end of the story for the 2022-23 budget. John Swinney in the Chamber made it clear that there could be further implications for the Scottish Budget from the UKG’s Autumn Budget on 17th November, perhaps even for 2022-23. And it is also clear that many pay deals are far from settled.

Only 12 more sleeps until the next fiscal event!!

Authors

Mairi is the Director of the Fraser of Allander Institute. Previously, she was the Deputy Chief Executive of the Scottish Fiscal Commission and the Head of National Accounts at the Scottish Government and has over a decade of experience working in different areas of statistics and analysis.

Adam is an economist 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.