State of the economy: September 2019

Overview

Growth in the Scottish economy has slowed through the first half of 2019 with continued Brexit uncertainty and a weakening in the wider UK and global economic environment impacting investment, sentiment and output. The analysis in this reports shows clearly the risks of a slowing economy, the continued impact of weak business investment on jobs and productive capital, which reflect the on-going Brexit uncertainty.

The contraction in output in Scotland in quarter 2, which reflects the unwinding of stock accrued by businesses in quarter 1, was not unexpected as the same pattern is evident in UK data (a contraction in quarter 2) and was widely anticipated.

However, the continued uncertainty relating to Brexit and the fact that business behaviour is still skewed to short term mitigation, rather than investment for growth or productivity, is impacting the economy more directly and weakening the overall resilience of businesses, which is a worrying trend and a risk to the economy. Updated analysis in this report considers the impact that this prolonged period of uncertainty could have and estimates that it could reduce or defer the level of business investment in Scotland by a further £0.5 billion by the start of 2020-21.

Scotland's labour market continues to perform strongly by historical standards, however the latest data shows a rise in unemployment in Scotland, albeit from record low levels. This, alongside continuing weak investment, the unwinding of business stocks, and subdued business and consumer sentiment, indicate that the economy is more vulnerable to an external slowdown and the risks of a No Deal Brexit from earlier in the year.

This contrasts with the position through 2018 in which the economy remained resilient, driven by continued strong domestic consumer demand, tourism and improvements in net trade. The latter reflects Sterling depreciation and new analysis in this report shows that Sterling depreciation may have had a greater impact on imports than on exports. However, more broadly, the slowdown in external activity, coupled with the continuing Brexit related risks, is now clearly impacting the economy in Scotland.

This makes predicting future growth more difficult as there is still no clarity on the form of Brexit - even in a No Deal scenario - and the extent to which there may be mini agreements or transition arrangements for parts of the economy. The independent forecasts for the Scottish economy reflect this uncertainty though most still assume some form of orderly EU exit and transition.

In contrast the recent Fiscal Risks report from the OBR (July 2019) suggests that the UK could contract through 2020 by around 1.4 per cent based on their most recent assessment, whilst the Bank of England suggest output lost to the economy could be as much as 5.5 per cent in the advent of a No Deal disorderly Brexit. It is our assessment that a No Deal Brexit would have an immediate dislocation for the economy and lead to a contraction in output in Scotland through 2020 and rising unemployment. The scale of the downturn could be potentially worse if external conditions continue to soften also and the economy continues to be weakened in the run up to any EU exit.