Manufacturing recovery not yet secure despite exchange rate benefits

The EEF/BDO Manufacturing Outlook survey for the third quarter shows that, despite last week’s stronger PMI data for August, activity levels remain largely unchanged from the second quarter, while manufacturers’ confidence about future prospects for the overall UK economy have taken a knock.

In contrast to the prospects for the UK, however, the export picture looks more positive on the back of the fall in Sterling and stronger demand from the EU, US and emerging markets. However the flipside of Sterling’s depreciation has been increased pressure on profits this quarter with price increases planned for the next three months.

After a sideways move this quarter there is an expectation across the sector that output and orders balances will finally move into positive territory by the end of the year. This is supporting plans for recruitment across some sectors in the next three months, but is not yet sufficient to prompt a turnaround in investment plans.

According to EEF, with subdued investment intentions and fragile confidence in the UK outlook, government will need to proceed quickly in developing an ambitious industrial strategy to make the UK an attractive proposition for future manufacturing investment. This will become even more critical once negotiations to leave the EU begin and Article 50 is triggered.

Commenting, Ms Lee Hopley, Chief Economist at EEF, said: “Manufacturers’ confidence collapsed in the aftermath of the referendum, but our latest survey provides some relief that this has corrected. Signs of an export revival are helping to drive more optimism about activity in the second half of the year, but concerns about whether the UK economy can shrug off post-referendum challenges is clearly evident.

“These risks are expected to hit some sectors such as with industries linked to investment goods and construction harder than others. Despite the short-term outlook for manufacturing remaining broadly stable, the continued downward slide in investment plans should keep policy makers alive to the potential risks facing the sector.”

Tom Lawton, Partner and Head, BDO Manufacturing, said: “While the outlook for the UK economy remains uncertain, manufacturers are more confident about their own business performance. This shows they believe there is a positive way forward from here and that Brexit might not have been the portent of recession.

“Some sectors are clearly facing longer term structural challenges where global factors are at play and these are unlikely to abate anytime soon. However, history shows that in difficult economic circumstances there are always sectors and companies that thrive on being driven to innovate, develop new products and search out new markets and customers. These are the factors that successful companies will be focusing on to continue this improvement in business performance.”

According to the survey, output went into reverse in the last three months, with the balance dropping to -7% from -4% in Q2, although this is expected to return to growth in the final quarter (+4%). While this was reflected in most sectors, mechanical equipment suffered a big decline on the back of poor investment intentions and the cutbacks in the oil & gas sector.

Order in-take also disappointed in the past three months, deteriorating slightly to -4% from -2%, with all sectors under-performing against expectations. Mechanical equipment again bore the brunt of the decline (-17%). The uncertain demand in the UK economy was reflected in a balance of –9% in the last three months and although the balance for the next three months has moved into positive territory to +4% the domestic outlook remains uncertain.

In contrast, however, export orders have exceeded expectations moving into positive territory in the last quarter to +2%, the highest balance since 2014q2. In the light of the fall in Sterling manufacturers are far more positive about future export orders, +12%, with the biggest driver appearing to be demand from the EU. The sector picture remains extremely mixed with electronics and electrical equipment posting the best export balance whilst, in contrast, the outlook for the mechanical equipment and basic metals sectors looks very challenging.

Manufacturers’ recruitment of new employees, lost momentum in the third quarter and fell into negative territory (-5%). However, future intentions have turned round to +8%, perhaps reflecting recruitment plans that were put on hold ahead of the referendum now being resurrected. Investment prospects continued to deteriorate, down for the fourth consecutive quarter to -10% from -9%.

The survey also showed that manufacturers’ profit margins were squeezed considerably as a result of rising input costs from Sterling’s depreciation, with UK and export margins at -22% and -21% respectively. However, price pressures are set to ease in the final quarter as UK prices turned positive for the first time since 2015q2, providing some relief for manufacturers’ profit margins.

EEF’s forecasts for UK growth were revised in July, following the referendum, and our growth projections for the economy this year and next remain unchanged at 1.7% and 0.8% respectively. However, forecasts for manufacturing output have been revised up to 0.4% in 2016 (from -0.3% in July) and -0.7% in 2017 (from -1.1%).

The survey covered 450 respondents between 4th and 24th August.