Rising grocery and housing costs leave many consumers struggling, but business confidence is slowly improving

The economic environment remains challenging for businesses and households. While the inflation rate is moderating it remains high and energy prices continue to put upwards pressure on the price of goods, services and wages.

The Chancellor’s budget set out plans to incentivise business investment and to encourage early retirees and parents of young children to return to work. This has also brought £320 million of Barnett consequential funding for the Scottish Government. However, despite tax rates rising from April and healthier than expected tax revenues in January that boosted public coffers by £5.4 billion, UK public spending remains constrained, with the Chancellor’s focus firmly on stability and keeping a cap on inflation.

The consumer prices index (CPI) measure of inflation rose by 10.1 per cent in the 12 months to January 2023, down marginally from 10.5 per cent in December 2022. Although the Bank of England’s monetary policy committee’s view is that global and UK inflation have peaked, it voted in February to increase interest rates by a further half a percent to 4 per cent, noting that UK pressures, including higher than expected private sector pay and services prices rises, remain a concern.

Grocery prices have risen by 16.7 per cent, and the cost of housing and household services 26.7 per cent year-on-year to January 2023. These rising costs will be felt by all households, with the impact felt most keenly by those on lower or fixed incomes. According to the marketing data and analytics company Kantar, a quarter of consumers say that they are now struggling financially, compared to one in five this time last year.

For most workers, pay increases have not matched inflation. Although regular pay rose a substantial 6.5 per cent, pay in real terms in October to December 2022 adjusted for inflation fell by 3.2 per cent for total pay and 2.4 per cent for regular pay – one of the largest falls for two decades.

The outlook is for the rate of price increases to fall this year. The Bank of England forecasts that inflation will fall to around 4 per cent by the end of the year, while other institutions such as the Office for Budget Responsibility (OBR) and Citibank are more optimistic, estimating that inflation could as fall to as low as 2.9 per cent and 2.3 per cent respectively by the end of the year. This is only slightly above the Bank of England’s 2 per cent inflation target, which has not been met since July 2021.

Thus, despite an outlook for slowing prices rises, the squeeze on households will continue. The OBR now expects real living standards in the UK to fall by 5.7 per cent over the period 2022/23 to 2023/24. While this is an improvement on its November 2022 forecast it would still be the largest fall since records began in 1956-57. 

UK and Scottish economies narrowly avoid recession but growth in 2023 will lag

UK GDP is estimated to have grown by 0.3 per cent  in January 2023, an improvement on the 0.5 per cent fall in December 2022. The latest quarterly data showed there was no growth meaning that the UK narrowly avoided a recession, defined as two quarters of decline. 

Scottish output followed a similar pattern with a 0.6 per cent fall in December and a marginal rise of just 0.1 per cent for the quarter as a whole. In December a drop in services output, from health and related services, was one reason for lower activity reflecting some strike days and lower levels of Covid-19 related activities such as vaccinations.

The UK’s trade deficit (the difference between the value of exports and imports) grew in the three months to January by £3.5bn to £27.6bn. The decline in the value of both UK imports and exports is due in part to the falling value of energy and chemicals. The trade in goods deficit increased over this period whilst the trade in services surplus narrowed slightly. A drop in the values of exports of fuels and processed raw materials such as metals was one reason for the widening goods deficit in January.

Food and Drink Federation data shows that exports of food and drink, worth an estimated £25 billion, fared well in 2022, with most categories exceeding pre-pandemic levels. Whisky exports account for around a quarter of the total value and a 37 per cent rise in the value of Scotch whisky exports in 2022 to £6.2 billion would have been a major contributor to export growth.

The OBR is forecasting a contraction in UK output this year but at a smaller rate of -0.2 per cent. It  also predicts the recovery in growth will be slow. While this is an improvement on earlier predictions, pre-Covid levels of GDP growth are not expected to return until 2026 according to the Bank of England, which cites “the change in the trading relationship with the EU” along with lagged effects of the pandemic and continued higher energy prices following Russia’s invasion of Ukraine as key factors.

The Fraser of Allander Institute forecasts that Scotland will see a sharper correction this year of -1.0 per cent before a gradual recovery in 2024, with marginal growth of 0.6 per cent. This is a downwards revision on its previous forecast, reflecting the expected impact of continued high costs of living and doing business. However, this may be revised up in the next quarter to reflect the three-month extension to energy bill support for households which was announced in the budget.

Last year, the UK was in the top half of faster growing global economies with output growth of more than 4 per cent. However, according to IMF data, weaker growth and higher relative energy costs mean that we will be the only advanced economy to see a decline in 2023 following last year’s relatively strong bounce back, and will continue to lag behind many of our competitors’ growth rates in 2024.

Employment rate at record high but tight labour market conditions expected
to loosen

Despite slowing economic growth, Scotland saw a record-high employment rate in the final quarter of last year with the proportion of people in work (of those economically active) rising to 76.5 per cent while unemployment fell to a historic low of 3.1 per cent, down on the same period a year ago.

Businesses continued to report difficulties in recruiting staff at the end of 2022 according to the British Chambers of Commerce (BCC), with 82 per cent of firms reporting recruitment difficulties, up from 76 per cent in the previous quarter. Firms in the hospitality sector report the most severe difficulties, followed by manufacturing, professional services and healthcare.

Unemployment is expected to rise in the short term as the economy contracts, with the Bank of England forecasting that UK unemployment will rise gradually to 5.3 per cent by the end of 2025. According to Skills Development Scotland, Scotland will fare slightly better, with unemployment forecast to peak at 4.7 per cent at the end of 2024.

The BCC also indicates that despite tight labour market conditions, investment in training is lower than one might expect with just one in four firms increasing their investment in skills over the last three months, 60 per cent reporting no change and 16 per cent reporting a decrease in investment.

Energy costs will continue to impact household and business decisions

The Energy and Climate Intelligence Unit notes that energy costs in the UK reflect a dependence on gas, exacerbated by the onshore wind ban and the relative inefficiency of UK housing with less than 2 per cent of UK homes having the top energy-efficiency ratings. This suggests that fluctuating energy prices will continue to be a factor in determining our economic performance for some time.

In January, Scottish retail sales increased by 7.9 per cent on a like-for-like basis compared with January 2022, slightly above the three-month average increase (7.6 per cent) but below the 12-month average (9.5 per cent). The Scottish Retail Consortium points out that this sales data is underpinned by an uptick in spending on discounted items for non-food retail sales, and that the rises in spending on foodstuffs reflect a rise in food prices rather than volume of sales, which has fallen.

The Office for National Statistics reports that around two-thirds of UK adults surveyed say they are spending less on non-essentials because of the rising cost of living with almost a quarter borrowing more than usual to make up shortfalls.

Reflecting these difficulties, consumer sentiment has also fallen. In the quarter to December 2022, the Scottish Consumer Sentiment Indicator, an experimental dataset which measures current household sentiment and expectations for the future, was -28.1, a drop of 10.4 points on the last quarter and the lowest recorded since 2013. We would expect this to feed through to spending decisions this year though we may expect a slight improvement this quarter because of a further three months of household energy relief and the fuel duty cut. 

Costs are also rising for businesses. The Fraser of Allander Institute found in its most recent quarterly survey that just under half of businesses reported that they expected to reduce operations to some extent due to high energy costs, while almost 60 per cent of firms report they are considering making energy efficiency improvements due to increasing energy costs. However just over 60 per cent of businesses also said the cost of making improvements stops them from making these investments.

While the BCC’s December 2022 survey showed a slight improvement in expectations for profitability among UK firms, overall, the balance remains negative and at Covid-crisis levels.

In Scotland, the Royal Bank of Scotland Business Activity Index data showed output improving in February despite rising costs, persistent supply chain disruptions and the slowdown in the housing market. Scottish businesses saw a rise in new business won, though the rate of new activity was outpaced by most other UK nations and regions. Overall, business confidence among Scottish businesses is rising, albeit more slowly than in most other parts of the UK. 

Clare Reid is Director of Policy & Public Affairs, Scottish Council for Development and Industry.

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