National Strategy for Economic Transformation: second annual progress report

Economic Context

Economic Context

Over the past year, the economy has continued to face elevated inflation and high interest rates although inflation has come down from 10.1% at the beginning of 2023 to 2.3% in April 2024. Economic sentiment and conditions have improved since the beginning of 2024 and are forecast to strengthen moderately over the coming year, however the path for interest rates remains uncertain and will be an important determinant of the economic outlook.

The Scottish economy grew 0.1% in 2023 and despite contracting 0.5% in the final quarter of the year, has so far avoided falling into a technical recession. Latest data show Scotland's GDP grew 0.4% in the three months to February, indicating a slight strengthening through the turn of the year. The return to growth in services over the quarter is encouraging and particularly in consumer facing services given the cost of living challenges that continue to impact households. However, falls in output in production and construction sectors over the quarter emphasise the range of headwinds that continue to impact across the economy.

The inflation rate fell to 2.3% in April, its lowest rate since July 2021 having peaked at 11.1% in October 2022. The fall in electricity and gas prices alongside easing food price inflation have been key drivers of the fall in the inflation rate, however the overall price level is 22.5% higher than at the start of 2021, emphasising the scale of the change in prices that households and businesses have been adjusting to. The Bank of England raised interest rates to 5.25% in August 2023 and has held them constant since then to weigh on underlying inflationary pressures. Inflation is forecast to fall further towards the 2% target during 2024, raising expectations that the Bank of England will reduce interest rates to some extent during the year. The path of the reduction remains uncertain, however is reflective of strengthening consumer and business sentiment and the outlook for stronger growth.

Consumer sentiment has strengthened significantly over the past year as households have become more confident in economic conditions and their household finances. The Scottish Consumer Sentiment indicator was -6.2% in Q1 2024 a fall of 1.1 points from the previous quarter. The indicator, remains in negative territory reflecting the ongoing cost of living challenges facing households and caution in spending money. The fall in inflation rate over the past year alongside a return to real earnings annual growth since June 2023 are key factors likely to be supporting the improved sentiment.

More broadly, Scotland's labour market continues to perform strongly with unemployment remaining low at 4.4% and the number of payrolled employees rising over the year to 2.45 million, remaining close to its record high level. The inactivity rate has picked up by 0.7 percentage points to 23.4% with "long term sick or disabled" remaining the main reason for being inactive. The underlying tightness in the labour market has eased over the past year however as vacancy rates and recruitment activity has slowed with the share of businesses experiencing a shortage of workers or difficulty recruiting on a downward trend.

Business conditions more broadly have also continued to evolve with business activity strengthening over the second half of 2023 and into 2024 while there are indications that business concerns around energy prices and inflation have been stabilising and converging with an increase in concerns about falling demand and competition.

Looking ahead, the Scottish Fiscal Commission forecast, published in December 2023, predicts Scotland's economic growth to strengthen to 0.7% in 2024, rising to 1.1% in 2025. The recent improvements in growth, business activity and consumer sentiment and resilience in the labour market underpin the stronger growth outlook for the year ahead. Downside risks to the economic outlook remain, notably from developments in the Middle East including disruption to shipping through the Red Sea.