EEF blog

Today we had a couple more positive pieces of data release relating to the end of last year. December has proved to be a much stronger month than originally expected and this may be a tentative sign of markets beginning to pick up and stabilise.

The PMI hinted at a strong end to 2012 for the UK…

• The positive 51.4 manufacturing PMI for December gave us a positive surprise telling us that orders on balance were up for the UK.
• January’s PMI was slightly weaker at 50.8 but remained above the crucial neutral-50. 

While the UK is looking more positive that it did for much of 2012, some of the UK’s key markets give us a bit of a mixed picture.  Our European counterparts continue to struggle and are firmly in contraction and, while there is some variation between countries, most PMI's remain below the 50 mark. The US and China look better with above 50 PMIs signalling improving operating conditions for the manufacturing sector in these respective economies.

…and today’s data confirms that the manufacturing sector finished 2012 on a high note

• Manufacturing output rose by 1.6% in December after contracting 1.2% in October and 0.4% in November. Combined this led to a small upward revision to manufacturing output to a contraction of 1.3% in 2012q4.
• The UK’s balance of trade improved to £3.2bn in December, from £3.6bn in November.
• Goods exports to EU countries fell £0.6 billion in December but rose to non-EU countries by £1.4 billion. 

Patterns of UK trade have been shifting over time with around 50% of our exports now going outside of the EU. This is up from 38% in 2002. However, the EU remains an important trade partner and, with economic conditions continuing to look worrying in the year ahead for the Eurozone, companies that export heavily to the EU may find 2013 to be quite tough.  Manufacturers with trade links outside of the EU will likely fare much better as exports grow faster and demand for products from emerging markets is expected to pick up. 

Today’s PMI is a positive surprise as we start off the New Year telling us that 2012 ended more strongly than expected and beating expectations by a considerable amount. The consensus forecast was for an unchanged negative outturn with the headline index expected to rise to 49.7 from 49.1 in November.

Instead the December PMI surprised us at a positive 51.4

The rise in output and orders at the end of last year is a positive signal that the sector can continue to grow in the year ahead

This positive PMI indicates that more manufacturers saw production increase than decrease in December. This is the highest PMI recorded for 15 months and is also the first time since April 2012 that the PMI has been back in positive territory.

However, the strength of recovery will continue to depend on what happens in other parts of the world

A major area of concern remains exports which showed a contraction – export orders remained below the neutral 50 while overall orders were above 50. Looking out to those key export markets shows that things are still looking patchy.

• The Eurozone continues to struggle and the Eurozone PMI remained relatively unchanged at 46.1, down from 46.2 in November.
• The US fiscal cliff deal that was agreed yesterday has provided some relief to the risks and has lifted markets around the world as they opened for business in 2013. This is not the end of the challenges though and more decisions will need to be taken in the year ahead. 

UK manufacturers and exporters, in particular, will be hoping to see stability in the eurozone and signs that demand will continue to hold up in the US and emerging economies in the coming months.   

PMIs across most of the Eurozone improved in August…

Yesterday Markit economics published its monthly PMIs for the UK and the Eurozone. The composite PMI for the Eurozone improved from 44 in July to 45.1 in August as did many of the larger Eurozone economies. 

… but they are still squarely negative.

The international environment does not bode well for export-focused manufacturers and continues to threaten the export-led recovery we have been hoping for.

• Ireland has been an outlier for most of this year. However, the drop in August brings Ireland closer to the negative territory that all other Eurozone countries have been in for the large part of 2012.
• The easing of the PMI in countries such as France, Germany and Spain may be an indication that that pressure is starting to ease off. But remaining in firm contraction territory they signal that the manufacturing sector is likely to continue to drag on Eurozone growth into the third quarter of 2012.
• The US PMI worsened slightly from 49.8 to 49.6  and the Fed has recently hinted that further quantitative easing might be on the cards.
• China, worryingly, has worsened once again as the uncertainty stemming from the Eurozone drags on growth prospects. The Eurozone crisis has permeated confidence around the world and emerging markets are feeling the pinch.

As Lee discussed in her blog yesterday, the weakening in economic indicators over the past few months, the slowdown in output and orders in our Business Trends survey and the worsening trade balance led us to lower our forecast for the year ahead. Unfortunately yesterday's PMIs reinforce the view that times look challenging for export-led manufacturers.

Flicking past the continuing coverage of Team GB's awesome medal tally and then the continuing coverage of the eurozone crisis in the FT, there is an interesting piece on some of the factors that have contributed to the long term success of the German Mittelstand.

Policy makers often look at this particular part of the continent and look for the qualities we should seek to emulate in the UK.  And never more so than now as we struggle to generate growth based on trade and investment that our economy needs.  So what are the secrets of the Mittlestand - here's five to get started with. 

...but has someone already let the cat out of the bag?

1. Innovate and retain a manufacturing base in your home market

We've been writing quite a bit about innovation recently.  It's key to growth, key to driving productivity gains and for a majority of UK manufacturers, it's key to meeting their strategic objectives, according to our Shape of British Industry survey. If there is no such thing as a sustainable competitive advantage in manufacturing, innovation is a vital area of investment that can keep companies ahead of the competition.  

Take a chemicals company that, in response to rising raw materials prices, responded with innovation to redesign some of its product range to minimise price increases for customers without compromising quality. 

This agility was helped by having production and innovation closely linked.  The production process can be as important when it comes to world class manufacturing.  For some manufacturers, there are clear advantages to having core manufacturing activities in the home market.  Our Global Value Chains survey showed that one in seven companies had returned some production from lower labour cost economies back to the UK because inconsistent quality, unpredictable lead times and variable costs were undermining their competitiveness.

2. It's all about services too

And it's not just product innovation that matters for UK manufacturers.  EEF's Innovation Monitor shows a steadily increasing proportion of manufacturers engaging in service innovation.  As one capital equipment manufacturer put it "it's no longer enough to sell product, you have to provide the support services that will maintain it through its life cycle". 

In addition to being a differentiator, more UK manufacturers are deriving revenue from such services, which can provide a cushion through a period of weaker demand.

3. Help train future employees

For UK manufacturers, recruiting and retaining skilled employees has been an uphill challenge for more than a decade.  With problems at multiple points in the STEM skills pipeline UK companies have become more and more active in building a talent pool for the industry.  Last year's Manufacturing Workforce survey showed that 55% of manufacturers were planning to up their investment in skills in the next 12 months and that the recruitment of new apprentices was also high on the agenda. 

Good practice can be found in the machinery sector with one company working closely with other local manufacturers to maximise the recruitment of apprentices and the benefits that brings to the community and supply chain.  Another large company has a long running relationship with local schools, offering opportunities to visit the company and supporting the delivery of the STEM curriculum.

4. Expanding into foreign markets is essential - but be careful

UK manufacturers are clearly looking beyond the domestic market and the sluggish growth prospects in Europe for other potential bright spots.  In May markets outside Europe overtook our traditional EU trading partner as the main destination for goods exports.  But even this underplays some of the significant growth rates in exports to emerging markets over the past few years - see our exporting medals table for more details. 

5. Harness networks

Collaboration happens in the UK too.  It is important for companies of all sizes when it comes to product development and forward planning.  Collaborative activity can strengthen supplier and customer relations, improve demand visibility, reduce costs and improve flexibility.    

PS When is a 2.9% month on month fall in output good news?  When the consensus was expecting a fall of 4.3%. 

The Index of Production data for June was always likely to signal a sharp drop in output, given the disruption to working patterns over the Bank Holidays.  However, the latest manufacturing figures from ONS suggest the fall was a lot less than first estimated.  So what does this tell us ... well not a great deal.  Our feedback still suggests that although confidence is fragile there is still growth to be found in overseas markets. The real question is whether July's data will confirm that output was simply displaced or whether we really have got something to worry about. 

The downward adjustment to the second estimate of overall growth in the first quarter 2012 was disappointing to see. This was largely driven by weaker than previously estimated output in the construction and the non-manufacturing production sector. 

This headline figures does not tell the whole story and below this sits a more nuanced picture – there are some positive signs that confidence may tentatively be increasing in the economy but also signs that reinforce the challenges the UK faces.

So what do the underlying stats tell us?

Some of the interesting news includes:

• Business Investment grew by 3.6% in Q1 2012.  Within this manufacturing investment grew 5.2% and non-manufacturing grew 3.4%. 
• The net trade position deteriorated from a deficit of £4 billion in Q4 2011 to £4.4 billion in Q1 2012.

The growth in business investment is a sign that UK companies are starting to increase confidence. It is early days yet but does this signal the beginning of the long-anticipated recovery of investment?  Forecasters have been predicting investment levels to pick up for a while but at the same time the precise timing of this recovery has been continually pushed out. 

Manufacturing investment has continued to show stronger growth than non-manufacturing investment. With the exception of Q2 2010, growth in manufacturing investment has remained stronger than other sectors since late 2009.

The deterioration in the net trade position in the first quarter was a result of both higher imports and slightly lower exports. Lower exports to the EU are worrying but not entirely surprising given current events and weak growth in the Eurozone but it is comforting to see exports to non-EU countries continuing to grow. 

Ongoing challenges face UK companies, from difficulties accessing finance to the intensification of strains in the UK’s major export markets in Europe. Despite the positive business investment stats, the process of rebalancing still has a long way to go.

Trade figures released this morning showed that the UK’s trade in goods deficit was unchanged between February and March.

While exports to Europe were flat over the month, reflecting challenging economic conditions in the region, exports to non-EU countries continue to look strong. Non-EU markets are providing a real boost to exporters: once again, hitting a record level in March.

EEF’s recent export survey showed that even amid the economic turmoil we saw last year, nearly 65% of companies surveyed saw an increase in total export sales in the last twelve months. The focus of exporters is predominately geared towards emerging markets, where manufacturers expect to see strong growth in the next five years. As domestic and traditional markets remain weak, 45% of companies said they were more interested in exporting to new markets than they were a year ago.

However, challenges remain for UK manufacturers. It is still the case that around half of all UK exports go to Europe. With news this morning that the region narrowly missed a return to technical recession, and a Greek exit looking increasingly likely, the economic situation on the other side of the Channel will remain a challenge for UK companies.

Similarly, exporting to emerging markets is not easy. There are specific barriers to entry into most new export markets, from business practice or language differences to exchange rates or poor credit protection; or a lack of knowledge about specific markets.

But UK manufacturers are ambitious, and are putting the foundations in place to continue the growth in exports to new markets that we have seen throughout the recovery so far.

This morning’s preliminary GDP release shows UK output continued to fall in Quarter 1 2012, putting the UK back into a technical recession.  Overall industrial output was dominated by weak construction activity that has dragged down overall output. 

The key quarter on quarter changes are as follows:

• Total GDP fell 0.2%
  
• Manufacturing output reduced by 0.1% but figures suggest output increased in month of March
  
• The construction sector, the main driver of the economy re-entering recession, fell by 3%

What is happening in Manufacturing?

The quarterly contraction in manufacturing is a concern.  However, on the back of negative growth in January and February the quarterly figure points to output growth of 0.2 in March. 

So, how does the overall picture fit with recent economic indicators?

Some indicators clearly fit with the overall story told by these weak GDP figures.  Worsening credit conditions and continuing low consumer confidence are both concerning as they are likely to act as a constraint on household and business activity, further slowing recovery.   A continuing weak construction sector will also continue to dampen growth prospects. 

The picture is not all bad though and the underlying health of individual sectors is not clear. The Purchasing Managers Indices for both Manufacturing and Services have been positive for the first quarter of 2012 and a raft of private sector surveys, not least of which EEF's own Business Trends Survey, broadly agree that there has been modest improvement in manufacturing trading conditions in the first few months of the year.  With the manufacturing sector growing in March and output for the services sector growing by 0.1% for the quarter we have reason to be cautiously optimistic. 

Trade figures for the three months to February 2012 also improved following record high exports to non-EU countries at the end of 2011.  These markets are crucial and will be of growing importance as the UK looks ahead to recovery.

Overall, these GDP figures are both a reminder of the big challenges facing the UK and world economies, and a confirmation of the patchy and unsteady recovery that we have been expecting.

This morning’s national accounts release shows a small downward revision to GDP data for the last quarter of 2011 and an improved current account deficit.

The key statistics

• GDP growth in Q4 2011 has been revised down to -0.3% from the previous estimate of -0.2% bringing annual GDP growth to 0.7% for 2011. 
• Manufacturing output fell in Q4 by 0.7%, a lower reduction than previously reported. 
• The UK current account deficit reduced to £8.5b in 2011q4 from £10.5 billion in the previous quarter on the back of strong exports during the end of 2011.  Export of goods rose 4% in the last quarter reducing the trade deficit to £4 billion. 

So what does this mean for the economy in the year ahead?

Last week the OBR substantially lowered their expectations around the role business investment will play in the recovery.  Business investment has struggled to recover over the past few years and the hurdles of finance and uncertainty remain in 2012. Significantly more growth is now expected to come from the Household sector.  In the Q4 2011 Household consumption expenditure saw a small positive contribution to growth.

Low confidence around the world continues to pose a major risk and challenge to the business environment.  The uncertainty from the Eurozone will likely continue to damage demand but there are some positive signs of export growth to emerging economies.  The big question is – to what extent will low worldwide confidence impact on demand over the coming year? 

On a positive note, the trade figures provide some confidence that firms are responding well to the weakness from the Eurozone crisis.  The strengthening Purchasing Managers Index in the first few months of 2012 also shows businesses are more positive about prospects and activity.

While these figures are not likely to materially impact the OBRs projections of future growth, they reconfirm the challenges that the UK was facing during the end of last year.  The positive trade figures for 2011 offer better prospects for economic rebalancing in the year ahead.

ONS data shows that UK exporters ended last year on a high. Total exports hit a record high in the final quarter of 2011, as did exports to non-EU countries.

The record levels exports has made some headway into the overall trade deficit and points to signs of rebalancing across the economy.  It is critical this trend continues through 2012, given the reliance on net trade and investment to drive GDP growth this year.  

So, what is the outlook for exports in the year ahead? See our blog post from earlier in the week: here.