Cost of living pressures set to intensify the UK’s regional economic divide, finds latest EY report

The forecast says that UK Gross Value Added (GVA) is expected to decline 0.6% over the course of 2023, with London (-0.2%) the only part of the country predicted to see a smaller economic contraction than the UK overall. London’s estimated 2022 GVA growth of 5.5% was the fastest in the UK, while only Scotland (5.3%) and the East of England (4.3%) join the capital in being expected to have seen better GVA growth than the UK as a whole (4.1%) last year.

Although Scotland is expected to match the overall UK GVA performance in 2023 (also contracting 0.6%), other parts of the UK are forecast to lag behind. Yorkshire and the Humber and the East Midlands are predicted to see the steepest GVA contractions, at 1% each.

Driving the contraction in UK output in 2023 are the forecast declines in services most dependent on household spending. With consumers struggling amid cost of living pressures, this year’s worst performing sectors are expected to include wholesale and retail (-3.3% GVA contraction), accommodation and food services (-2.7%), and arts, entertainment and recreation (-1.8%). Manufacturing (-2.9%), which relies on consumer spending to maintain demand, also faces challenges relating to higher input costs such as raw materials and labour, alongside increased borrowing costs.

At the other end of the spectrum, less consumer-dependent sectors like administrative and support services (0.8%) and professional services (0.1%) are expected to see some growth, while sectors like real estate (-0.2%) and financial and insurance services (-0.5%) are forecast to see smaller contractions than the rest of the economy.

How does London’s economy compare to the rest of the country?

London’s resilient performance is founded on its sectoral mix and the important role played by its knowledge-based sectors, including the professional and financial services and the information and communication sector. In high value sectors, the forecast says that London was the only region to record a higher GVA per employee (£116k) in 2022 than the UK overall (£77k).

By contrast, Yorkshire and the Humber, the East Midlands and the North East are the most exposed regions to the UK’s five slowest growing sectors – and least exposed to the five fastest growing. Weakness in manufacturing and retail are significant factors in the forecast GVA contractions for Yorkshire and the Humber and the East Midlands, while the East Midlands also registered the country’s lowest GVA per employee in high value sectors (£48k) last year.

At the same time, the report’s analysis notes that people in London and the South East have more capacity to absorb rising prices than counterparts elsewhere, with the two regions the only areas in the UK with mean weekly incomes above the national average (£621). People in the North East (£544), Yorkshire and the Humber (£548), Wales (£548), and East Midlands (£557) have the lowest average incomes.

The pattern in GVA growth is reflected in jobs, with only London, Northern Ireland and Wales expected to perform better than the UK as a whole in 2023. Job numbers in these three areas are expected to be effectively unchanged this year, and down 0.2% across the UK. The West Midlands is forecast to trail the rest of the country, with job numbers shrinking 0.4%. London is also forecast to see the highest increase in its working age population in the medium term, with annualised growth of 1.2% between 2024 and 2026.

Rohan Malik, EY’s UK&I Managing Partner Markets & Accounts, says: “The rising cost of living is likely to exacerbate the differences in regional economic performance, widening regional inequalities and heightening the need for economic policy which spreads growth out across the UK. Levelling-up presents an opportunity to boost growth for the whole of the UK – but familiar patterns are still all too present as the economy recovers from the pandemic.

“London clearly enjoys advantages in economic resilience, skill levels, and in productivity – both in higher and lower skilled sectors. But London’s performance also offers lessons for the rest of the country. Sector composition is key for regional economic performance, for example. Regions need their own visionary sectoral growth plans that define roles for the private sector, alongside government, as investors, employers and economic agents in their regions. It’s also vital to unlock investment in skills and encourage labour retention.

“The key to nurturing a strong sector composition is investment in high value-added sectors, like advanced manufacturing and information and communication. The transition to Net Zero, for example, represents a generational opportunity to rebuild the manufacturing base, upskilling workers in new energy generation and operation capabilities across the value chain from construction of solar farms, heat networks and hydrogen pipelines to electric vehicles and charging infrastructure. A one-size fits all approach won’t work though, and regions need to understand their own strengths, weaknesses, and sub-sector opportunities.

“High value sectors won’t function without a high value workforce and, too often, regions struggle to retain and uplift their skill bases. Fixing this needs to be approached from several angles: graduate and skills retention relies not just on the development of well-paid jobs, but strategic planning on the broader set of social, environmental and structural components that determine the quality of life in a given region too.”

Which parts of the UK economy will have recovered to their pre-pandemic size by the end of 2023?

The new forecast also says that, by the end of this year, UK GVA is expected to be 0.1% higher than it was in 2019, with London (up 3.2%), Yorkshire and the Humber (0.6%), the South West (0.5%), the East of England, Northern Ireland and the East Midlands (all 0.3%) outpacing the rest of the country. The West Midlands (-1.7%), South East (-2.1%) and North West (-2.5%) are forecast to be furthest from their pre-pandemic levels.

Further out, over 2024-2026, UK GVA is expected to grow at an annual average 2.1%, with London growing 2.6% per year. The South East (2.2%), South West (2.1%), East of England (2.1%) and West Midlands (2.1%) are also forecast to outpace or match wider UK growth. Like London, the West Midlands and the South West are both expected to be boosted by strong growth in the information and communication sector, which is expected to be the UK’s fastest growing sector in the medium-term.

Meanwhile, the North East, Scotland, Yorkshire and the Humber, and Wales (all 1.7%) are forecast to see the slowest growth in the country.

Which cities are expected to have the fastest growing economies?

The Regional Economic Forecast includes an analysis of the economic prospects for the UK’s towns and cities, and the report predicts that a handful of towns and cities are set to outperform the rest of the country this year. Joining London (-0.2%) among the largest towns and cities forecast to match or beat the overall UK GVA performance in 2023 (-0.6%) are Reading (0.7%), Manchester (0.4%), Bristol (0.3%), Newcastle (0%), Cardiff (-0.1%) Glasgow (-0.2%), Belfast (-0.4%) and Cambridge (-0.6%). Manchester (0.6%), Bristol (0.5%) and Reading (0.5%) are expected to see the country’s fastest employment growth this year.

Reading, Bristol and Manchester – all likely to enjoy strong growth in professional, scientific and technology services, the information and communication sector, and in administrative and support services – are also forecast to perform well over the medium-term. Reading (2.7%) is expected to be the fastest growing location in the country over 2024-26; Manchester (2.5%) and Bristol (2.4%) are expected to be just behind the capital (2.6%).

The leading smaller locations in the medium-term are forecast to be Windsor & Maidenhead (annual average GVA growth of 2.4% over 2024-26), Brighton (2.4%), Lichfield (2.4%), the wider Thames Valley (2.4%) and Chorley (2.4%). Four of the five slowest growing areas are in the North, with Durham (1.2%), Hull (1.2%), Rotherham (1.4%), Hartlepool (1.4%) and Plymouth (1.4%) trailing the rest of the country.

Peter Arnold, EY UK Chief Economist, comments: “Sectors are again a key factor in forecast performance at a city and town level, and it’s not a surprise to see growing tech hubs like Reading leading the table for expected growth. While the pandemic put pressure on city centres or supply chain-dependent manufacturing areas, the rising cost of living is likely have the biggest impact in places that are dependent on their local High Streets or public sector jobs.

“There’s also a North-South divide in the pressure on consumers, with petrol consumption among the key cost increases over the last year. This is more likely to be more of an issue for those outside London and the South East, where commuting or travel by car is more common. By contrast, the rise of post-pandemic homeworking is more prevalent in London and the South East, areas which, in any case, benefit from extensive public transport coverage.

“When considering regional inequality, economic inactivity is also likely to be a key factor. While this has grown in all but two regions since the pandemic, a handful of areas have seen particularly large increases. A large proportion of those leaving the workforce are between 50 and 64 years old, with long-term illness identified as a key driver. The withdrawal of experienced skills from the workforce will be a drag on performance, while those dealing with long-term health issues will need support.”

The three non-London English regions to see the largest increase in their share of economically inactive people after the pandemic are the North East (24.6%), the North West (22.5%) and the East Midlands (22.2%).