Scotland to avoid recession despite flat economic performance, says the EY ITEM Club

• Recession may be avoided with economic growth remaining flat since 2022 Q2, but Scottish GVA is expected to rise by 0.3% in 2024 as inflation eases, real incomes rise, and interest rates begin to fall
• A resilient labour market suggests no significant rise in unemployment is likely, but employment will remain broadly flat in 2024 before increasing in 2025 and 2026 as the pick-up in growth feeds through to jobs
• Sentiment among Scottish businesses and households appears to be fragile and sensitive to a backdrop of persistent high interest rates and above-target inflation, despite the recent ONS announcement
• Scotland’s major cities are likely to perform better than the Scottish average, with Edinburgh and Glasgow’s economies running ahead of Scotland in each year of the forecast. Sectors such as information and communications, and business services sectors are set to lead the way 

Resilient consumer spending may have helped the Scottish economy avoid a recession, but economic growth has been flat since Q2 of 2022 and will remain into 2024  when GVA is expected to rise by 0.3%, according to the EY ITEM Club Scottish Autumn forecast.

The forecast adds that sentiment among businesses and households remains fragile against a backdrop of persistent high interest rates and above-target inflation, despite the recent announcement by ONS that inflation appears to be decreasing.

The prospects are better for 2025 (Scottish GVA expected to rise by 1.3%) and 2026 (Scottish GVA expected to rise by 1.5%), with the economy expected to gain momentum. In part due to Scotland’s labour market demographics, growth will remain low in historical terms and is expected to lag the UK as a whole. However, when London is removed from the forecast, Scotland’s expected growth performance is similar to the rest of the UK.

Overall, a slight rise in unemployment is anticipated in 2024 to 4.2%, lower than the 4.5% forecast for the UK, whilst employment will remain broadly flat through 2024. Over the period 2024 to 2026 we forecast total employment to grow by an average of 0.6% per year, lagging the UK average of 0.9%.

The EY ITEM Club says that, in the face of a flatlining economy, the Scottish labour market has held up well but there are signs of softening. Wages have grown ahead of inflation, yet, employment faltered at the start of 2023 and recent indicators show that the growth in employees has levelled off, unemployment has risen – albeit from a historically low base – and the number of vacancies has decreased.  

EY Scotland Managing Partner Ally Scott said: “This year has seen a similar pattern to 2022, with periods of growth punctuated with points of decline. The net result is that while Scotland’s economy has avoided a technical recession so far this year – with a more resilient performance than expectations suggested – it was nevertheless slightly smaller at the end of Q2 2023 than it was a year earlier.

“We expect to see promising signs in the economic outlook towards the end of 2024 into 2025 and 2026 as the economy gathers pace, lifting employment numbers above pre-pandemic levels.

“Scotland’s major cities are likely to perform better than the Scottish average thanks in large part to their sector profiles, with Edinburgh and Glasgow running ahead of the rest of the country in each year of the forecast. This, along with a weaker expectation for Aberdeen, continues a five-year trend leading up to the pandemic. However, we will watch with interest to see if recent policy and project developments for the North East – especially on construction related to energy transition – deliver a positive impact for both the local and wider Scottish economy.”

EY Scotland Managing Partner for Financial Services Sue Dawe said: “Many sectors experienced a see-saw of trading conditions as government, society and businesses navigate continued global uncertainty.

“Manufacturing output and mining and utilities activities have fallen, which means overall output from Scotland’s production industries shrank in the first half 2023. However, international goods exports have been more encouraging, with Scottish goods exports growth slightly ahead of the UK in value terms.

“Continued economic strains have a broadly similar impact on Scotland’s economy as they do on the rest of the UK and global markets, but the expected recovery of household finances later in 2024 will benefit consumer facing sectors, as public services also bolster the rate of economic growth.”

Scotland sectors

With the exception of the energy sector, which is expected to recover output lost in 2023, no sector is expected to gain any real impetus next year, according to the forecast. It is probable that GVA growth in the manufacturing sector will mirror the economy-wide average of 0.3% in 2024, while transport equipment sector has the potential to grow, reflecting easing supply disruptions and recent buoyant domestic and international demand. Prospects for the manufacturing sector are better for 2025 in line with economy wide average.

Output from the construction sector in Scotland has held up well so far in 2023, despite the weak economic environment. While the rate of output growth is expected to slow next year, the EY ITEM Club forecasts an acceleration in 2025, and the sector should outperform the economy wide average over the forecast period.

The recovery of household finances later in 2024 will benefit consumer facing sectors, with accommodation and food forecast to see above-average growth, though the projected rate of expansion is modest in historical terms. Improving consumer sentiment will gradually feed into retail activity and output from wholesale and retail should pick-up in 2025 when consumer expenditure is expected to rise by 1.5% (and by 1.8% in 2026), with the increase in consumer spending also benefitting the arts, entertainment, and recreation sector.

Public services will bolster the rate of Scottish economic growth somewhat, particularly next year, with the health sector providing the largest contribution and education too outperforming the average GVA growth in 2024. However, public finances remain tight and the public administration and defence sector, which makes a relatively large contribution to the Scottish economy, is not expected to show any meaningful growth either this year or next.

The EY ITEM Club says the outlook is somewhat mixed for the business services sectors, particularly in the near term. The short-term outlook is rather more encouraging for information and communication and administrative and support services, but even here the rates of growth will be low by historical standards. However, over the medium-term it is the business service sectors that should begin to pull ahead, with information and communication leading the way.