State of the economy: May 2022

Overview

This edition of the State of the Economy presents new analysis on how the economy has been impacted by the three recent economic shocks: Covid, EU Exit and the war in Ukraine. As the economy continues to rebalance from the pandemic, it is facing new and unexpected challenges, with the nature and pace of rising inflation putting significant pressure on household finances with weak consumer sentiment and further raising costs for businesses already dealing with supply-side challenges. This is at the same time as fiscal and monetary policy has begun to tighten, with tax increases coming into effect in April alongside an increase in the energy price cap, and central banks in the UK and elsewhere starting to increase interest rates.

Scotland's GDP has continued to recover from the pandemic, growing 0.4% in February, and is now 1.3% above its pre-pandemic level in February 2020. The removal of remaining Covid restrictions in April marked an important stage in the domestic recovery. However, risks to the recovery are heightening, with latest data showing the UK economy shrank by 0.1% in March, as higher prices started to weigh on trade in the wholesale and retail sector.

Scotland's labour market has remained robust at the start of the year with the unemployment rate falling to 3.2%, (its joint lowest level in the series) and the number of payrolled employees rising to 29,000 above its pre-pandemic level. However, labour market conditions remain tight with low unemployment accompanied by persistently high vacancy rates and demand for staff. This continues to place upward pressure on nominal earnings, which rose by 6.8% over the year to March, however, didn't maintain pace with inflation, resulting in a fall in real earnings.

Trading conditions remain challenging for businesses. Bottlenecks in supply chains, in part due to Covid restrictions in China, are proving persistent while the war in Ukraine and the resulting sharp increases in global commodity and energy prices are also exacerbating cost pressures. Our analysis also suggests a drop in trade intensity and openness in the UK economy which may also be contributing to higher input costs post EU exit. In addition, business are also facing upward pressure on wage costs, with ongoing staff shortages particularly concentrated in specific sectors of the economy such as in Accommodation & Food services.

Looking ahead, the economic outlook has weakened rapidly since the turn of the year. Levels of consumer and business sentiment have declined as cost of living challenges have sharpened and expectations of continued higher inflation and lower growth have set in. This is reflected in the latest forecasts from the Bank of England and the International Monetary Fund (IMF), warning of a risk of recession. The Scottish Fiscal Commission (SFC) due to present its latest forecast of the Scottish economy on 31 May. Regardless of whether the economy formally enters a technical recession, it is clear we are entering a difficult period for economic growth, household incomes, and living standards.