EEF blog

Having been out of the office for a couple of weeks, I've spent yesterday afternoon catching up on last week's economic data when the vacancy figures (which Felicity flagged up last week) got me thinking.

Manufacturing vacancy rates (i.e. openings per 100 employee jobs) have been on the rise over the past year, up from just 1.1% in April 2010 to 1.7% this April. Rising vacancy rates area good and worrying signal for the health of the industry. 

Firms tend to recruit only when output and orders are expanding and they're are, at minimum, modestly confident about the next few months. This is why manufactuirng added a net 14,000 jobs in the fourth quarter of 2010.

But if rising vacancy rates reflect skill shortages, that could help push up wages. For example, in the rush of the downturn, vacancies plummetted as firms were focused on holding on to skilled workers. This helped push wage growth down, as employees were took pay cuts, in large part to keep their own jobs, but also because there weren't jobs elsewhere.

Now coming out of the recession, we see that vacancies and wage growth are again, moving in tandem (except this time around it looks like wage growth is slightly ahead of vacancies). This could be because firms are setting wages for the year ahead, and are factoring their recruitment plans. It also reflects that firms are rewarding staff that stuck through short-time working and pay cuts.

But the rapid rise in the vacancy rate, coupled with anecdotal evidence of skill shortages, suggests that vacancies could be yet another factor that could lead to higher wage growth.

Moving in tandem?
3-month average pay settlement (% annual increase) and manufacturing vacancy rate (vacancies per 100 employees)

Source: EEF & JAM Recruitment Pay Bulletin and ONS

In the FT today, Peter Marsh reports that the government’s ‘rebalancing agenda’ has been criticised for being incoherent. This may be true. The term 'rebalancing' does seem to be used with a degree of abandon to refer alternately to regional, industrial or public/private balance, depending on which is most convenient at the time. While there is, in fact, rationale behind each of these uses we would point to two key elements of rebalancing.

As David Willets noted in a speech last year:

“Future growth has to be driven by business investment;
it needs to be export led”

In this speech Willets mentions the importance of innovation to drive both of these things.

But what exactly is innovation?

David Willets notes that:

Innovation covers “a broad range of activities” and is “more than research and development, vital though that is. Knowledge transfer, design, branding and customer insight all matter”

He is right. Innovation is broad. But it is also targeted. Companies innovate as a response to competitive pressure. Innovation is commercially driven. And this is why it is so broad, competitive pressures do not just apply to products. Developing new processes or marketing techniques is equally innovative, and equally important to maintaining a competitive edge.

So innovation is commercially-targeted development of any or all elements of a business. And Willets is right, it's crucial for growth. Or, for that matter, rebalancing.

Last week we were disappointed by data suggesting that on a pro rata basis, the banks were falling short of their target of lending to SMEs agreed in February with the government under the so-called ‘Project Merlin’. That data related to 2011q1.

EEF’s latest credit conditions survey, conducted in April and May, gives the first indications of credit conditions in 2011q2.

And as we have noted in the press, we are pleased that at last we have some good news on access to finance for SMEs in the UK. Our survey shows a net positive balance of companies reporting an increase in the availability of credit in 2011q2 – the first such positive balance since we started asking these questions in 2008q4.

Perhaps more important than this overall balance however, is that small companies in particular – those with up to 100 employees – are showing an even balance with as many small firms reporting an increase in availability as a decrease. This is a change as until now small firms balances for availability have been consistently negative.

Access to finance has until now been very much a two-sided story. Larger companies, which also happen to have more options available anyway, have consistently found it easier to access finance.

Smaller firms on the other hand have struggled. They rely on accessing credit through banks. Since the financial crisis banks have been less keen to lend to SMEs, at least partly because the banks needed to wind back their exposure after having over-extended themselves.

So an even balance for small firms is potentially a key breakthrough.

The next announcements to watch on credit conditions will be the Bank of England and BBA lending trends figures for April and May coming out in June.

But before we break open the champagne and pat the banks on the back, we need to recognise that the cost of credit continues to rise.

The availability of finance, on existing credit arrangements, shows a balance of -7.3% overall, falling to -13.3% for small firms in particular. This backs up what we hear from talking to firms that when they are refinancing with their bank, they’re finding the costs and conditions tougher.

And further, unfortunately, 2011q2’s survey showed a continuation of the trend in place over the course of the recovery, with a persistent balance of companies reporting an increase in the cost of credit.

This is virtually unchanged with a negative balance of 28.3% for all companies reporting an increase in the cost of new lines of borrowing, decreasing further to -30.2% for small companies.

The fact that some small companies must be entering their second round of refinancing since the financial crisis implies that margins are persistently lengthening from the finance providers.

The cost of finance issue, particularly if we consider costs outside of headline rates, is suggestive of the need for higher competition in the UK banking sector.

And despite the availability result, the two speed finance recovery between small and large firms continues, especially on cost; suggesting a greater variety of sources of finance is very much still a relevant concern for SMEs.

Despite showing a cracking improvement in net trade, this week’s GDP release didn’t give much cause for comfort. At best, the economy stagnated over the last six months. This was a result of weak domestic demand. In particular, as Duncan Weldon pointed out in a blog earlier today: consumer spending fell considerably in the first quarter.  

But it is not all bad news on the consumer-front. In fact, this week there have been two rather more positive developments: 

1. Earlier this week Barclays’ survey of inflation expectations showed a significant drop in the median 12-month inflation expectations of the general public from 4.3% in January to 3.3% in April. This could suggest that consumers are a little less worried about squeezed incomes in the coming year.* 
2. Today GfK NOP released their consumer confidence indicator for May, which jumped by 10 points to -21, rising across all five sub-indices.
   

Both of these could be short-term blips, rather than longer term trends. In particular GfK NOP note that their index could be showing a temporary bounce due to “the feel-good factor of the Royal wedding and a double-whammy of sunny bank holidays, or to the recent let-up in negative reporting about the state of the economy”.

Whatever the case, if the joys of spring have provided a little respite for the British consumer, this is no bad thing!

* The Bank of England’s own inflation expectations survey is due out on the 9th June.

Back in March I asked where growth was going to come from in 2011. And today’s GDP release gives us some idea. The main source of growth in 2011q1 was net trade, on the back of strong export growth. This is good news for a better-balanced economy.

What is perhaps a little perplexing, is that the other positive contribution to growth this quarter was government spending. But, as the bloggers over at FT Alphaville have pointed out, “that’s partly a quirk of the way departments spend more at the turn of fiscal years, much as the VAT rise was especially nasty for household spending this time”.

But this means that investment and consumption both dragged on growth. Consumption is probably not something anyone will be surprised by, with the continued squeeze on households, but investment is another story. The fact that investment fell in 2011q1 does not look like good news for rebalancing.

While I don’t wish to argue that a fall in investment was a good thing, perhaps a little perspective is needed. Manufacturing investment growth has lagged behind output growth in every recession since the eighties (manufacturing went into recession in the 2000s). In fact, despite the dip in manufacturing investment this quarter, it has rebounded more strongly than at the equivalent point following the previous recessions.

Figure one: manufacturing investment (Index: last quarter of recession = 100)

Source: ONS, Oxford Economics and EEF

It is not just investment that is stronger, but according to EEF’s Business Trends survey, manufacturers' intentions to invest were stronger in q1 than at the equivalent point in the 2000s recovery. In both cases, actual investment has lagged behind intentions, so we can't write off an investment-driven recovery just yet.

EEF’s q2 Business Trends will be out on Monday 6th June.

In an article in the Telegraph today Jeff Randall claims that the Bank of England is failing this country.

The case for the proposition?

• CPI hit 4.5% in April, and may well continue to rise
• Inflation has now been above target for 51 of the past 60 months
• Prices rising faster than pay means continued squeeze for households

These are all valid points. The Bank has indeed failed to keep inflation below target in the last few years. But that does not mean that it is failing the country now.

Changes in monetary policy can take up to two years to feed through to the economy. So for the Bank’s policy setting, inflation at the moment is not as important as what inflation will be.

As Adam Posen has continued to argue, the MPC would “help no one in this economy by setting our policy to compensate for past mistakes rather than basing it on our best forecast”

True, the Bank’s forecasting record in the last few years has been far from faultless, but it remains the case that the risks to inflation in the medium term are finely balanced.

We may yet see lower inflation, as recent and projected weak growth reduces price pressures.

Similarly, some of the risks to higher inflation may not materialise. Wage pressures are one of the biggest risks to inflation but so far labour market data from ONS last week, and EEF’s own Pay Settlements data, out today, shows that although pay is rising, it is doing so slowly, at levels not associated with worrying inflationary pressure.

Domestic demand in the form of consumer and government spending is expected to be weak in the coming year, so economic growth will be reliant on investment and net exports.

The good news is that last year exports grew strongly: in 2010 goods exports grew by nearly, 17% the fastest rate since 1977.

This has been driven by some really stunning growth in exports to emerging economies:

Figure 1: growth in value of goods exports 2009 - 2010

Yesterday’s labour market statistics released by the ONS will have provided some comfort for the members of the Monetary Policy Committee. Not only were employment figures relatively healthy – indicating that the underlying economic situation could have been stronger in the past few months than GDP data suggests – but growth in average weekly earnings also remained at a low-enough level to stave of fears of a price/wage spiral.

Average weekly earnings growth is some way below the pre-recession average of a little over 4%. Across the whole economy average earnings growth was 2.3% in the three months to March. This was slightly higher than in February, but this can be attributed to increased bonuses in Finance and Business services: when bonuses are excluded, average pay growth actually fell from 2.2% to 2.1% between February and March.

Figure 1: Average weekly earnings growth

On the flipside, the number of hours worked in the economy as a whole fell slightly, over the quarter, despite the numbers of full-time employees rising, and a fall in the number of part-time employees. It could be, then, that pay awards are rising a little more quickly than the headline figures suggest. But, even then, earnings growth is some way from its average levels, and it remains well below CPI.