EEF blog

As trailed by other recent data releases, the latest GDP estimate for the second quarter was revised up to a contraction of 0.5%.  So the UK's economic performance wasn't quite as dire as the first cut of data suggested.

But as we said last month it's still difficult to take the figures at face value as the impact of additional bank holidays will have had a material impact on output across a number of sectors - inlcuding manufacturing. If activity has been displaced rather than lost - as was the case in previous Jubilee years - most of the ground lost in the second quarter should be made up in the third.

However, the second estimate provides a bit more detail on the components of growth and these are the areas we need to be watching closely. 

Trade and investment are what's needed for rebalancing the economy.  But growth across both components appears to be nowhere in sight, not just in the most recent quarter, but over much of the past year.

Th ongoing euorzone crisis and the slowdown in some emerging markets is casting a long shadow over the UK and this is being reflecting by the drag that net trade is having on economic growth.  Despite hopes that net trade would be a big contributor it has had a positive impact on growth in only five quarters since the end of the recession.

And there's been a similar trend with investment. It's not yet outwith the bounds of possibility that the Office for Budget Responsbility's March forecast of a 0.7% increase in business investment could materialise in 2012. But for the private sector to chalk up an increase of nearly 6.5% next year looks challenging given recent trends. 

Manufacturing does, however, seem to be bucking the investment trends. Capital expenditure across the sector rose more than 5% in the second quarter, pushing investment levels around 13% higher compared with a year ago. The strong focus on productivity, the need to replace machinery with the lastest technology and investment to support entry into new markets or supply chains are all likely to be playing a part in driving more postive investment trends across manufacturing.

So manufacturing investment is perhaps a glimmer of good news amongst data which is largely pointing underlying weaknesses across the economy. Regardless of the size of the rebound in Q3 it's clear that kick-starting the rebalancing process is going to need a fair bit more effort from policy makers.

Ahead of tomorrow's GDP release for the first quarter of 2012, what do the most recent economic indicators suggest about the state of the UK Economy?

The decision:

The MPC voted to maintain the Bank Rate at 0.5% and continue with asset purchases totalling £325bn

All nine members of the committee voted in favour of maintaining the Bank Rate. Only David Miles voted against maintaining the level of asset purchases, favouring an increase of £25bn.

The committee noted the recent unexpected falls in manufacturing output and construction seen in ONS data this year and thought that this (combined with the mechanical affect of an additional Bank Holiday as a result of the jubilee) might mean that GDP would fall in the first and second quarters of this year. In addition, Euro area instability continues to present a risk to the UK economy. However, it was felt that underlying activity had probably picked up since the second half of 2011.

CPI has started to fall back, though at a slightly slower rate than had previously been expected, meaning the path for inflation was likely to be higher than that forecast in the most recent inflation report.

Upside risks to inflation:

• Rising oil and commodity prices
• Domestic companies seeking to rebuild margins to improve cashflow
• Nominal wage growth outpacing productivity improvements

Downside risks to inflation:

• Demand too weak to absorb the margin of spare capacity in the economy
• Potential for further economic contraction might dampen business and consumer confidence
• Households and businesses building up a buffer of savings might slow growth

Economic developments over the month:

(NB the MPC’s meeting was held before much of the recent escalation in Spanish government bond yields)

Financial markets

• Conditions in financial markets continue to normalise
• Functioning of bank funding markets had improved
• Fall in short-term funding costs in the Euro area

International markets

• Global PMIs suggest that growth rates were similar to those seen in the first half of 2011
• Euro area PMIs, however, suggested that economic activity in the region was weak
• Steps to restructure Greek debt had been agreed
• US growth looking stronger
• Chinese data consistent with gentle slowing in activity
• Oil prices remained elevated, compared with the start of the year but increased little over the month

Money, credit, demand and output

• UK GDP fell in the fourth quarter of 2011
• Manufacturing output fell in February, though this was at odds with more positive business surveys
• Service sector surveys suggest growth in the first quarter
• Construction saw another large contraction, which is likely to depress GDP growth in the first quarter of 2012
• Credit conditions likely to remain tight

Supply, costs and prices

• CPI down to 3.4% in February (since the meeting CPI inflation was reported as 3.5% in March). The fall was a little less than expected
• CPI likely to be higher than previously forecast
• Picture from labour market mixed, with unemployment elevated and wage settlements running at about 2.5%
  

This morning the ONS will release the Index of Production for January, which will provide the first official statistics for manufacturing growth in 2012.

EEF’s own Business Trends survey – also released this morning – suggests that companies have had a positive start to the year.

After weakening at the end of 2011, this quarter’s survey showed the balances of businesses reporting increased orders and output strengthen in the last three months.

The crisis in the Eurozone hit confidence in the final months of 2011, and official statistics showed that manufacturing output contracted towards the end of the year. However, a closer look at these statistics suggests that this weakening may have been relatively short-lived. Although manufacturing output fell in October and November the sector grew again in December. The manufacturing PMI followed a similar pattern, returning to positive territory in January. Our survey this quarter also suggests the dip in activity was a temporary one. Confidence about the next three months has recovered to levels reported in early to mid-2011.

The positive outlook has fed through to strengthening investment intentions, although the outlook for cashflow continues to weaken, suggesting companies may struggle to translate positive intentions into real investment. We still need to hear more from government to ensure that investment proceeds and generates much-needed growth.

We do expect manufacturing to grow in 2012, though the weak end to 2011 and the continuing volatility in the global economy have caused is to revise our forecasts down to growth of 0.5%. We anticipate that the sector will regain some momentum in the latter part of the year, translating into stronger growth of 1.8% in 2013.

The decision:

The bank rate was held at 0.5% and the asset purchase programme was extended by £50bn to £325bn.

All nine members voted to extend the asset purchase programme. Two members voted for a £75bn increase.

Recent developments:

Financial markets

• European financial markets fared better since the the ECB’s additional long-term refinancing options (LTROs) in December.
• Short-term bank funding markets had also improved.
• Spanish and Italian bond yields had come down, though remained elevated.
• UK short-term interest rates had changed little over the month.
• Equity indices had started to improve.

The international economy

• Upside news on near-term prospects for global economy including positive PMIs.
• US growth looking stronger: 0.7% in 2011 q4.
• Even Euro area PMIs picked up in January, suggesting growth had not continued to weaken.

Money, credit, demand and output

• UK GDP fell 0.2% in the last quarter of 2011, broadly in line with expectations.
• Since then PMIs have improved sharply, though other surveys were weaker.
• First quarter of 2012 may be a little stronger than previously expected.
• Credit conditions for businesses and households remained tight, but bank funding markets improved since the end of the year which could lead to improvement.

Supply, costs and prices

• CPI fell to 3.6% in January, as expected.
• Employment rate broadly flat since November.
• Pay growth remained subdued and expected to remain modest.
• Little significant movement in medium-term inflation expectations.

GDP and inflation projections

• Slight contraction in the final quarter of 2011 followed a period of sluggish growth.
• Monthly indicators pointed to a pickup in output in January.
• There are continued substantial uncertainties surrounding the outlook for growth, most significantly due to developments in the euro area.
• Growth will be dependent on whether households start spending again (as real income squeeze abates); cost and availability of credit; impact of asset purchases on demand.
• Likely path for inflation also highly uncertain, with several unknown factors such as the path of energy prices.

Key risks to inflation

• On the upside:
  - companies’ input costs rising further
  - disruptions to gas and oil supply
  - earnings growth outstripping slow productivity growth
• On the downside:
  - growth too weak to absorb the pool of spare capacity
  - Euro area crisis increasing banks’ funding costs and feeding through into the availability and cost of credit
  - Slower than expected growth in household spending

Today’s labour market statistics do not make particularly comforting reading. One key measure, the ILO unemployment rate, edged up to 8.4%. Unfortunately, we expect that figure to continue to rise: averaging out at around 8.6% over the course of 2012.

The economic uncertainty resulting from the Eurozone crisis that overshadowed much of the second half of 2011 is likely to affect hiring decisions in the year ahead. And while positive balances of manufacturers intend to take on both temporary and permanent workers in 2012, this is highly dependent on the sector.

Some sectors, particularly Transport (which is more exposed than most to emerging markets), are more positive about taking on new employees in the months ahead, whereas a balance of Rubber and Plastics manufacturers expects to reduce headcounts of both temporary and permanent workers.

In addition, while companies often report positive recruitment intentions, these can sometimes be frustrated by skills shortages, which are a long-term issue for the sector.

The labour market statistics also showed that the number of working days lost to labour disputes was its highest level since July 1989. Although this number was skewed by the large public sector strikes on 30th November 2011, deterioration in workplace relations has been raised as a concern by some manufacturers.

Similarly, after a couple of years of pay restraint, companies are concerned that they will face significant pressure on pay, which – at a time when materials and other input costs remain elevated – could put additional pressure on margins and profitability.

So far manufacturers and their employees have worked together to ensure good workplace relations. During the downturn this resulted in fewer job losses than have previously been seen in recessions. Reflecting this, many manufacturers see maintaining good lines of communication with employees as a crucial activity in the year ahead.

There is some gloomy economic news this morning, with the Item club saying that the UK may have already slipped back into recession.

And unfortunately the executives surveyed in our Executive Survey 2012 report, published today, are also not positive on the UK’s economic prospects. Just over a fifth believe economic conditions in the UK economy in 2012 will be better than in 2011, but just under a half expect conditions to deteriorate. And unfortunately this spread of views is shared by firms of all sizes and across all industry sectors.

Manufacturing executives also indicated some concerns around how the situation across their own industry would evolve in the next 12 months. A balance of 11% of companies expects conditions in industry to be more difficult in 2012 compared with 2011. Certainly EEF’s fourth quarter Business Trends Survey indicated expectations of a weak start to the year as forward looking balances on output and orders dipped into negative territory for the first time in more than two years. However, there is some considerable variation across different sectors.

This view of the UK’s growth prospects together with dampened EU growth and the positive prospects for emerging economies means that nearly half of firms in our survey say that increasing demand for products in emerging markets will be an area of growth for them in the year ahead. I’ll be blogging about this later on today and discuss other areas of the report findings – firm level performance, risks to growth – later on this week.

Today we publish Economic Prospects: 2012 - our review of the key challenges that lie ahead for the UK economy and manufacturing in the next twelve months.

This blog sets out our central forecast for growth in 2012. Later today we will provide a couple of alternative scenarios.

If the economic outlook felt uncertain at the start of 2011, it is even more so as we enter 2012. If anything, the downside risks to growth appear more marked. This uncertainty is reflected in the huge range of expectations for the year ahead. Recent growth forecasts varied from predictions of an outright contraction of 1.3%, to growth of 2.0%.

Our own forecast is for GDP to grow by 1.0%, resulting from improvements in net trade and investment, but against a backdrop of weak consumer and government spending.

As with 2011, consumption is likely to be weak. The elevated levels of inflation which proved a major drag on spending last year should abate in 2012, but sluggish growth in the rest of the economy and a weak labour market are likely to hold household spending below par. 

Investment was a drag on growth in 2011. We are forecasting a turnaround in 2012, with investment growth of 3% providing a strong contribution to growth across the economy. However, there are considerable risks around this forecast. Although manufacturing investment grew strongly in 2011 q2 and q3, total business investment contracted. And many of the factors that held back investment in 2011 will still apply in the year ahead.

While manufacturers still report intentions to invest, this could yet be delayed if the uncertainty caused by the eurozone crisis continues, or if cashflow and access to finance remain constrained. Neither of these risks is insubstantial. 

Similarly, improvement net trade could be hit by the eurozone crisis, however, we are forecasting an improvement, particularly on the back of growing demand in emerging markets.

Tomorrow we publish Economic Prospects: 2012 - our review of the key challenges that lie ahead for the UK economy and manufacturing in the next twelve months.

Ahead of this, here is a look back at our predictions for 2011; how they played out; and why growth turned out to be slower than we expected.  

Back at the start of 2011 we laid out four key challenges for the year ahead:

• Access to finance;
• The impact of spending cuts;
• Commodity prices.
• Eurozone;

Unfortunately (but illustrating that economists can – sometimes – get it right) all of these proved problematic.

Access to Finance was an issue throughout the year, especially so for SMEs. After some modest improvement in credit conditions in the first half of the year, both cost and availability appear to have worsened again in recent months.  This does not augur well for 2012 given banks are looking to refinance themselves in this year, potentially against a background of very strained global financial markets.

Government spending cuts have significantly dented public sector employment. The OBR now anticipates these cuts will eventually top 700,000 compared with 400,000 at the time of the March Budget. At a time when private sector job creation was limited, this led to deterioration in the UK labour market in the latter part of 2011.

The first half of 2011 saw sharp rises in producer prices leading to consumer price inflation. The combination of higher-than-expected inflation and public sector job losses held down private consumption.

Commodity prices started to fall away in the latter half of 2011 as global demand slowed, partly as a result of our fourth concern: the escalating crisis in the eurozone. 

The biggest issue in the latter half of 2011, and one that looms large at the start of this year, was undoubtedly the eurozone debt crisis and its apparently infinitely delayed resolution.

The considerable amount of uncertainty the crisis has created has hit global demand. Faced with ongoing uncertainty, companies have put a premium on maintaining cash and are holding off investment. Customers from both within the EU and beyond, appeared to be holding off placing orders as concern for short term growth prospects became more acute.

So that was how our predictions played out. However, as the table below shows, our forecasts for GDP growth and for CPI normalisation proved over-optimistic. 

Why?

• A couple of unexpected events occurred: notably the Arab Spring (and its ensuing effect on the oil price) and the Japanese tsunami (which hit the supply chains of manufacturers in the UK)
• The greater-than-expected impact of the eurozone crisis had a significant impact on growth as it cast a large shadow over business confidence.
• Growth was also hit by markedly subdued consumption as consumer confidence was knocked by elevated inflation, and limited pay rises.

January's Economic Briefing, in which the outlook for the year ahead seems shaky, without concrete resolution to the Euro-crisis

EEF's Monthly Economic Briefing, available here.