Households can expect finances to improve but business activity continues to contract

05/02/2024

SCOTLAND’S economy is set to gain momentum this year with the prospect of interest rate cuts from May onwards, a continuing fall in inflation, and decreasing energy prices. Continued growth in pay and easing pressure on household finances should also boost consumer sentiment, according to the EY ITEM Club Scottish Winter forecast.

Scottish GVA growth is expected to be 0.7% in 2024, marking a considerable improvement compared to 0.1% in 2023, bringing it closer to the UK outlook (0.3% in 2023 and 0.8% in 2024). GVA growth prospects in Scotland are expected to improve even further to 1.4% in 2025 and 1.6% in 2026 and 2027.

News about inflation has also been more positive, with the consumer prices index (CPI) measure falling to 3.9% in the year to November 2023. Despite a slight rise to 4.0% in December, the significant fall in the rate of annual inflation during the quarter should have helped support growth in Scotland.

Scotland’s sectoral growth

As economic conditions and confidence improves, private sector services are set to drive growth from 2025 onwards. Among these, information & communication is set to lead returning annual GVA growth of 2.8% in 2025. Activity in other key business service sectors should also gather pace in 2025, most notably administrative & support services and professional, scientific, and technical services, returning growth of 1.8% and 1.7% respectively. The recovery in household confidence and spending over the medium-term will support growth in consumer-facing services, with accommodation and food services and wholesale and retail, posting above average employment growth over the 2024-27 period.

Tightening of the Scottish labour market and employment prospects

The Scottish labour market remains resilient as unemployment remains low and the outlook is anticipated to improve in 2025 with growth across most sectors. However, it is expected that over the longer-term, employment prospects will be dampened by weak demographic growth, particularly compared to the rest of the UK.

Businesses continue to report recruitment difficulties, with high rates of inactivity and economic uncertainty limiting the supply of candidates. The ONS Business Insights and Conditions Survey continues to report that Scottish businesses are struggling to recruit staff, with 36.8% of applicable businesses in November 2023 reporting difficulties recruiting employees. These issues are most acute in manufacturing, accommodation and food, and construction.

Fiscal events present opposing forces for Scotland’s higher earners

Despite the pressure easing on household finances, it should be noted that the proposed Scottish income tax increases for 2024-25 will create a further disparity between Scottish and UK taxpayers. A Scottish taxpayer earning £125,000 will pay £5,221 more in Scotland in 2024–25 than they would if working elsewhere in the UK. This may change after the UK Government’s Budget in March, but currently amounts to a fiscal tightening for an estimated 154,000 higher earners in Scotland.

Ally Scott, EY Scotland Managing Partner commented: “Although economic growth has been relatively flat, Scotland is slowly moving in the right direction with a brighter outlook expected for sectors such as information and communication, energy, and consumer-facing services. That said, there has been a softening in investor sentiment and challenges noted in the labour market, with employment growth remaining low and lagging the UK.  

“In what is already a constrained labour market in Scotland, the incremental increases in income tax have created a meaningful tax cross-border divide, which includes a significant number of NHS professionals, senior teachers and other civil servants. This is now a major concern for employers in Scotland looking to retain talent in an already tight skilled labour market. If these growth sectors hold the careers of the future for Scotland, then we need an environment that encourages investment and promotes business, not one that creates barriers for growth or impacts competitiveness.” 

Sue Dawe, EY Scotland Managing Partner for Financial Services said: “The outlook for the remainder of 2024 is somewhat a mixed picture for Scotland, but we do need to consider the longer-term access to a skilled workforce, both in terms of attracting and retaining talent. The new Scottish Financial Services sector growth strategy demonstrates that maximising the potential of this long-established industry for modern times requires a skilled workforce for us to compete on an international stage.

“Financial Services is crucial to a balanced economic growth trajectory in Scotland, supporting emerging technology sectors and the green energy transition. But we need to incentivise our people to stay in Scotland and push for others to see Scotland as a place to build a successful career, rewarding life and, of course, contribute to a thriving, just, local economy.”

Business activity and sentiment

The latest PMI Scotland Business Activity Index remained in contractionary territory at 49.4 in December, an improvement on 47.1 reported in November, but again lagging the UK at 52.1. December’s Scottish Government Business Insights and Conditions Survey shows that the main concerns for firms were inflation in goods and services prices (16.6%), followed closely by falling demand for goods and services (16.3%). Energy prices, whilst still a significant concern for 14.6% of businesses, fell to third place having previously been the primary concern among businesses in the last quarter.

The BICS survey also found that a larger proportion of businesses reported a fall in turnover (24.4%) than businesses reporting an increase in turnover (17.2%) in November compared with October. The results by sector suggest that the accommodation and food services and administrative and support services are most likely to have experienced weak activity at the close of the year. Yet, the EY ITEM Club reports that we can expect green shoots of growth in these sectors as we enter 2025.

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