Energy prices offer respite for households but recession risk remains and food inflation remains high
There has been some respite this quarter for households as energy prices in the UK, as in other countries, have fallen. However, price pressures from other sources continue. There are signs that businesses are unable to absorb these for much longer and that households are adjusting their spending. Scotland is forecast to escape recession this year, but with a drop in output in the latest quarter the risk remains.
Inflation may have peaked but price rises are still impacting households and employers
Globally, headline inflation rates have fallen in most economies this summer because of a decrease in energy prices. Food inflation however remains high, with the UK seeing the fastest rise in the year to June 2023 of all OECD countries.
Rising costs continue to put pressure on households and employers though there are signs that some of these pressures are easing. Energy prices remain high but both gas and electricity rates have fallen rapidly in recent months.
The annual rate of inflation including housing costs slowed in July to 6.4 per cent (down from 7.3 per cent in June) and fell 0.4 per cent month-on-month. Hotel prices and passenger flight price rises contributed to upwards pressure and food prices rose by a substantial 14.8 per cent in July though this was slightly slower than in June.
Upwards pressure also came from a rise in owner-occupier housing costs as mortgage rates have risen in response to the Bank of England base rate, which rose in August to 5.25 per cent, and from rising rents. UK private rents rose on an annual basis in July by 5.3 per cent and in Scotland by 5.7 per cent, though it is worth noting that the Scottish data may be driven by much higher rises in new lets over existing tenancies because of rent controls now in place.
A total of 51 per cent of adults in the UK report increased costs for their normal food shopping in August 2023, up from 43 per cent a few weeks earlier. More than two thirds of UK adults also report that as a result they are spending less on non-essentials, half are shopping around more, and more than 40 per cent were using less gas or electricity in their homes.
This cutting back in expenditure is reflected to some extent on Scottish high streets. In July, total retail sales in Scotland increased by 4.6 per cent compared with the same month a year ago when they rose 4.4 per cent. However, this was below the three-month (9.1 per cent) and 12-month (8.5 per cent) averages and adjusted for inflation represented a year-on-year decline of 3.0 per cent. Poor weather was also thought to have contributed.
Inflationary pressures are also impacting businesses, though the rate of increase in input prices in Scotland slowed in July according to the Royal Bank of Scotland UK purchasing managers’ index (PMI), a survey of private businesses.
Data from the Fraser of Allander (FAI)/Addleshaw Goddard quarterly survey in August confirmed that two in three firms have absorbed price rises over the past year rather than passing them on to their customers, particularly in the wholesale, retail, construction, and manufacturing sectors, but also that more than half of these are either unable to continue to do so, or unsure how long they can continue to do so.
Inflationary pressures are expected to ease with fewer businesses in the survey in Q2 expecting to raise prices compared to Q1. The bank expects inflation to fall further towards the end of the year, as energy prices and goods costs fall, though services inflation is expected to take longer to come down.
Wage rises and inflation gap narrows
Early estimates for July suggest the median monthly pay for payrolled employees in the UK rose by 7.8 per cent compared with the same month a year ago, down slightly from the peak of 8 per cent in June. In Scotland it rose by 8.1 per cent.
Despite these pay increases, inflation across the UK has, until relatively recently, continued to rise ahead of earnings. Recent analysis by the Resolution Foundation found that for the three months to May 2023, compared with the same period two years ago, weekly wages had fallen in real terms by 4.1 per cent taking account of inflation with public and public-funded sectors squeezed by as much as 9 per cent compared to the private sector (2.9 per cent).
As vacancy rates have risen in public sector roles the Foundation predicts the UK Government will need to either “limit or redress some of the relative pay cuts in coming years” to address this. This disparity has prompted strike action and the UK has seen more strikes in the past year than it has since the 1980s. The service, transport, and mail sectors have been most affected, though in Scotland early pay negotiations have averted some similar actions.
The labour market remains buoyant but there are signs that conditions are softening which may impact on future pay settlements. In the latest data for the quarter to June the unemployment rate rose marginally, the employment rate fell slightly, and the number of inactive people also rose. Unemployment remains relatively low at 4.0 per cent, very slightly below the UK rate (4.2 per cent), while the employment rate is slightly lower (at 74.2 per cent) and the inactivity rate slightly higher (at 22.6 per cent).
Slightly fewer businesses in Scotland in the second quarter reported having vacancies than in Q1 according to the FAI but 84 per cent of these still reported difficulties in filling these vacancies. A lack of experience and applications as well as wage expectations were the top reasons given.
Business activity slowed, reflected in GDP fall
There has also been a slowdown in business activity over the summer. According to Scottish Government data just 22 per cent of Scottish businesses reported increased turnover in July, compared with May. In all, 26 per cent reported a decrease in turnover, with the figure rising to 39 per cent in manufacturing businesses. Other sources show similar trends.
July saw slower rates of business activity growth in Scotland relative to June, a drop in the backlog of work and lower rates of new business activity being won according to the Royal Bank of Scotland/PMI data. The FAI quarterly survey mirrored the overall trend underpinned by contractions in administration and support services, retail and wholesale and construction, while manufacturing, transport and storage and information and communications expanded.
And looking ahead, businesses in both surveys are less optimistic about future activity. Most striking is the drop in expectations for capital investment, with 40 per cent of firms in August in the FAI survey delaying or cancelling investments (primarily capital).
Economic uncertainty, affordability and the cost of borrowing were the most common reasons and half of these firms are either unsure if they will continue with these or have pushed them out to future years.
Reflecting weaker business activity levels, Scotland’s onshore GDP fell by 0.3 per cent in the three months to June 2023, following a small rise (0.2 per cent) in the previous quarter according to early estimates, with bank holidays and warm weather thought to be contributing to stronger output in some sectors and weaker trends in others.
UK GDP rose over the same period (0.2 per cent), following a rise of 0.1 per cent in Q1. A drop in Scottish manufacturing over the period (versus a rise in the UK) accounted for most of the rise in the UK and most of the fall in Scotland. The smaller relative contributions made by other sectors are also a factor and the Scottish economy remains 0.5 per cent smaller than pre-pandemic.
Globally, the Organization for Economic Cooperation and Development (OECD) projects GDP growth will be 2.7 per cent this year, the slowest rate (aside from 2020) since the global financial crisis, before rising to 2.9 per cent in 2024. It also predicts UK GDP growth of 0.3 per cent this year and one per cent next year, in line with the expectations of the Scottish Fiscal Commission for Scotland and broadly in line with the Fraser of Allander, which was slightly more optimistic in its June estimates. The Fiscal Commission also expects Scottish GDP to remain below two per cent for the medium term.
Household spending flat, sentiment still negative
UK households did not increase their spending in the first quarter of this year (the latest period available), relative to Q4 of 2022, although spending was slightly up on the same period in 2022. The largest positive contribution was spent on recreation and culture, while the largest negative impact came from a drop in spending on transport. A comparison with pre-pandemic data for Q4 2019 shows household spending has now decreased by 2.3 per cent.
UK consumer confidence remains negative on balance but according to GfK data, rose by five points in August relative to July. Scottish Consumer Sentiment, also still firmly in negative territory, rose by 5.3 in Q2 relative to Q1. Sentiment is still weaker than at any pre-pandemic point, suggesting that households continue to feel the impacts of ongoing economic and financial challenges.
Low levels of confidence as well as higher costs of borrowing are also having an impact on house prices. Office for National Statistics data shows that in June UK average house prices were £5,000 higher than the same period last year (1.7 per cent higher), compared to no change over that period in Scotland, though compared to May the rise was just 0.7 per cent (-0.4 per cent in Scotland).
More recent data from Nationwide reports that in August UK house prices fell on a seasonally adjusted basis by 0.8 per cent, the second consecutive fall. While this may be unwelcome news for sellers, this may ease some of the pressure for buyers though affordability relative to real wages remains an issue, particularly for first-time buyers.