EEF blog

Tomorrow brings the much awaited preliminary estimate of Q1 GDP, the first official data on for 2013. The question on many commentator and economists minds as they wait for the release is whether or not the UK will enter a feared triple dip.

Most economists are expecting GDP to be broadly flat, with many predictions falling between the -0.1% and +0.1% range.

What hints can other indicators give us?

Production: A recent blog by my colleague Felicity showed that manufacturing output will have to grow 1.6% in March to avoid contraction in the first quarter of 2013. While this level is not unprecedented given the monthly volatility we have seen in manufacturing output, it is almost certainly looking at a quarter of contraction. Clearly there is a lot going on within the sector so this will not be the case for all sectors - Aerospace and Mechanical have been more positive recently.

Looking more widely at all of production, there is a greater chance of production positively contributing to growth. Production output will be set to grow if March output contracts by less than 0.3%.

Trade: The overall trade deficit improved in January but worsened in February. We will need to see further improvement in the deficit in March for trade to not be a drag on growth over the quarter.  Export growth has been negative with exports reducing 2.1% and 2.7% in January and February respectively.

Industry indicators: Euro area PMIs have continued to show contraction across Europe, which has made conditions difficult for UK companies exporting to the EU. The US and Chinese manufacturing PMIs have been signalling expansion but at a slower pace. EEF’s Business Trends Survey shows the balance of 1% of companies saw output fall in the past three months but a balance of 22% are expecting them to pick up in the next three months. 

All up GDP is on a bit of a knife-edge and could go either way. For the record, we are expecting no growth in GDP over the quarter.

Does the sign really matter?

Whether GDP in the first quarter of 2013 is positive or negative is not really the key issue. Looking at the path of GDP over time it becomes obvious that GDP has been broadly flat for the past 18 months or so (see chart below). And if GDP growth comes in within the expected range, whether positive or negative, we will see a continuation of this trend.

GDP growth broadly flat for the past 18 months

GDP, chained volume measure, seasonally adjusted, 2009 prices

 
So, with growth still eluding us, the real concern shouldn’t be on whether we have entered a triple dip – which, if it does eventuate, could very well be revised away over time. The more important issue should be how can we get growth back on track? We are missing an overarching plan for growth, that will drive decisions and protect those areas of support that are most important for the long-term competitiveness of the UK.

Positive upwards revision to annual growth in 2012

While the third estimate of GDP for 2012q4 came in unchanged at -0.3%, upward revisions to the first and third quarter have raised annual growth from flat to positive 0.2% for 2012. The largest upward revisions were made to the agriculture and construction sectors.

However, investment and trade remain weak

Unfortunately, looking below this figure makes it clear that the investment and trade led recovery has yet to eventuate. We see that over the past year growth was held up by consumption and government, which each positively contributed 0.6% to GDP. Total investment was flat but there was a positive contribution to grow of 0.4% from business investment. Net trade, by contrast, was the weakest expenditure component of GDP, with a negative contribution of 0.8% to GDP.

% contributions to growth, quarter-on-quarter and year-on-year
 

Manufacturing investment also fell in 2012

Manufacturing investment contracted by 1% last year after strong growth of over 12% in 2011. This 2012 result is out of line with the continuing positive balance of investment intentions that we have seen in EEF’s Business Trends results over the past year. Early next week EEF will be publishing a report presenting findings from a new investment survey and setting out what needs to be done to encourage more globally focused companies to invest and expand in the UK.

So far our blogs on EEF's 2013 Executive Survey have highlighted that

• Manufacturers are a bit more positive about the UK's economic prospects compared with a year ago.
• Views on industry sub-sector performance are more divided - transport expecting growth; metals looking at contraction.
• Some firm level confidence that increased productivity and sales can be achieved this year.
• It should be game on for exporters, but only in non-EU markets.

This final blog picks up on some of the more upbeat firm level indicators. A number of opportunities are driving these positive expectations.

The most cited growth opportunity this year is from sales of new products as manufacturers see the benefits of their focus on innovation efforts. The proportion of companies expecting to grow on the back of this has leapt to almost 50% from just 10% a year ago. New service offerings also feature as a route to increasing sales this year with 27% expecting to services to generate growth in 2013.

As noted in our market outlook yesterday manufacturers are more optimistic about demand prospects in emerging markets and 45% expect these regions to offer growth opportunities for their businesses in the next twelve months - on a par with last year.

Also in the top three areas of potential growth is the opportunity to diversify into new supply chains. Second- and third-tier suppliers continue to see the benefits of companies further up the supply chain try to build security into their supply base by dual-sourcing or finding local suppliers instead of relying solely on overseas ones.

Inevitably, in the current climate it's not all good news. There are still choppy waters to be navigated in 2013 and the main risk identified by manufacturers in the year ahead is the potential for the world economy to weaken this year, hitting demand for UK exports. This is a marked shift compared with a year ago when concerns were focused on supply constraints, particularly the cost and availability of raw materials.

Recently there have been both sharp monthly movements in the value of Sterling. Risks around exchange rate volatility were cited as a concern by fewer than one in ten manufacturers in 2012, this has risen to 37% in our latest survey. Medium and large companies, most likely to be involved in multiple export markets, were more likely to see exchange rate volatility as business risk this year. 

Small companies, however, continued to be concerned about their ability to access the external finance needed to invest and grow over the course of this year. Government schemes to support the flow of finance are hoped to deliver further improvements for SMEs over the course of this year. Our latest survey, and indeed evidence from others, continues to show that risks around credit availability are set to cast a shadow over growth prospects for the next twelve months.

No year is risk free for manufacturers, which are exposed to fluctuations in exchange rates and commodity prices; competition from around the world; a push to constantly innovate for new products and services; and ever-present demand uncertainty. The latter risk appears to be the most heightened in the year ahead and the fortunes of the sector and the UK’s ability to rebalance its economy will continue to be closely linked to global events. As our survey points to continued action by manufacturers to develop new opportunities to grow their businesses, there is room for some cautious optimism that the sector can remain on track for recovery. 

We finish off the year today with some mixed news. ONS released their third estimate of GDP today. Main changes in today’s release: 

• GDP revised down by 0.1 percentage point to 0.9%.
• Manufacturing GDP revised to 0.7%, down from 0.9% in the previous estimate.
• Business investment stats remaining strongly positive and revised slightly upwards from 3.7% to 3.8%.

This is the first quarter for a long while in which all expenditure components of GDP made positive contributions to growth, as shown in the chart below. As we have mentioned in previous blogs, much of this is the result of a bounce back after disruptions in q2 that were caused by the Jubilee and the Olympics.

Contribution to growth, quarter-on-quarter, for the expenditure components of GDP
CVM SA
 

The outlook is not looking as positive as we would like going into 2013. We know from our business trends survey and the weak PMI that manufacturers will still be facing tough conditions nest year. The Monetary Policy Committee are predicting a contraction in headline GDP in the fourth quarter of 2012 and the underlying output in the near term to be broadly flat. However, output and investment are expected to begin to pick up further over the next two years.

Merry Christmas and Happy New Year from the EEF economics team!

Today’s Index of Production release shows the manufacturing sector contracted 1.3% in October and was 2.1% lower than it was in October 2011.

Once again the headline data disappoint as these stats show the effect of the continuing challenges facing the Eurozone and the global slowdown. As our Business Trends survey showed, much of the decline in output is being driven by the Eurozone, with companies with high proportion of their exports going to the EU showing particular weakness. This month was the first time since the end of 2009 that export orders were negative and the first time since 2008 where export orders were weaker than domestic orders.

The official stats are showing a similar story to our Business Trends survey results, with strong sectoral divergence. In fact, if we look back over the course of the recovery we can see that some sectors have performed well despite the challenges facing the economy.

Index of Manufacturing, 2009=100

The transport sectors, mechanical equipment and electrical equipment are showing strong signs of growth while pharmaceuticals, chemicals, rubber and plastics and coke and refined petroleum have performed relatively poorly during the recovery. 

As Lee pointed out in her blog on Monday, economic conditions will continue to challenge our manufacturers. However, there are some positive signs ahead. While the overall outlook is relatively muted, EEF’s Business Trends survey shows investment intentions remain high for the year ahead and some sectors are reasonably positive about the next three months. Our forecasts paint a continuing picture of sector divergence but with most sectors growing in 2013.

Since the financial crisis there has been broad agreement that the UK needs a new model of growth; one based on more trade and investment and less reliant on consumption by households and government. Through the stop-start recovery so far, there have been few signs that this process of economic rebalancing has really started to get underway.

Next week's Autumn Statement must signal that the government recognises its role in this process. There is little government can do to influence the more uncertain prospects in the global economy, which are weighing on export demand and confidence to make new investments. However, it can, and must, take steps to offset these external factors by making the business environment as favourable as possible to those companies looking to invest and grow in the UK.   

Over the next three days a number of external contributors to our blog will set out why government should be focusing on boosting business investment and putting some ideas forward on how this can best be achieved.

But first a quick summary of the UK's past and present business investment performance.

1. UK investment has some catching up to do

As a share of output the UK has historically not compared well with other developed countries on investment. And in contrast to the pick-up in investment levels noted in Germany, the US and Canada (not shown) since the end of the recession, the investment recovery in the UK has been stuttering. While the most recent GDP data for the UK in the third quarter point to some quarter on quarter growth, business investment has made a positive contribution to total economic growth in only two of the past six quarters.

Business investment as % GDP
Source: OECD

2. Recovery has fallen short of expectations

This is not where we thought we'd be at this point in the recovery. Back in June 2010 The Office for Budget Responsibility had pencilled in strong year-on-year increases in business investment making positive contributions to growth through the forecast period (chart on the left); the recovery was expected to get underway during 2010 being maintained through 2011 and 2012, with investment levels returning to their pre-recession peak during 2013. It was thought that corporation tax cuts and low interest rate would support the recovery. However, as of 2012q3 business investment was still 12% below it's pre-recession peak and on an annual basis investment isn't set to provide a meaningful boost to growth until 2013 (EEF forecast on the right).

contributions to GDP growth
Source: OBR and EEF

3. In manufacturing at the least, investment intentions have picked up strongly

Across manufacturing the intention to increase capital spending has been evident since the end of the recession in 2010.  EEF's Business Trends Survey saw a much more marked rebound in investment intentions in this recovery companies with the previous two recessions. The long lags between output turning a corner and investment getting underway following previous recessions impacted on manufacturers' productivity relative to competitors and manufacturers and their supply are looking to invest to ensure that can succeed in new markets and sectors both now in the medium-term. Government can play a role in addressing some of the reasons this isn't happening. 

% balance of change in investment intentions
Source: EEF Business Trends Survey 

Todays GDP release shows both the economy and manufacturing grew by 1% in the third quarter

Output across manufacturing and the wider economy has made a bit of a come-back, confirming that activity wasn’t lost, just displaced from the previous quarter. This has and should be welcomed; it is a positive development given the disappointing data that we have had in the year so far.

However, we need to take this number in context. The UK’s economic performance has been skewed recently by a series of one-off events, including the Diamond Jubilee in q2 and the Olympic and Paralympic games this quarter. The question we need ask as we interpret this figure is whether this first estimate is enough to signal an improvement in the underlying growth picture.

So what impact did the Olympics and Paralympics have on our figures?

The basic story is that it is difficult to fully quantify the overall impact of the Olympics but evidence suggests a number of components of the output measure of GDP are likely to have been impacted, both positively and negatively.

The largest impact comes from ticket sales, which are estimated to have added around 0.2 percentage points to the preliminary estimate of GDP

Other impacts, which are less easily estimated, could include more employment activity, greater use of accommodation and food and beverage services, more use of transport systems, and changes to shopping patterns.

The good news is that under the one-off events the economy is still growing but will the pace of expansion be maintained into the new year?

Unfortunately survey data, particularly in our major markets, continues to point to difficult trading conditions which make this unlikely, and world-wide economic conditions will continue to pose the most significant challenge for the UKs productive sectors.  

While today’s data release provides us with some reasons for cheer, the pressure is still on for the government to be clear about its economic priorities and to set a clear path that will continue to deliver growth in the forthcoming Autumn Statement.

But let’s finish with some positive news

Initial estimates are that manufacturing grew by 1% in q3. Looking in further detail at the early monthly data shows that in September the index of manufacturing grew by 0.4% in contrast to the Manufacturing PMI for September was quite negative.

The rise in manufacturing is a bit of an outlier, particularly when most other sectors are showing contraction – these initial estimates show production in total contracted by 0.8% in September and the services and construction sectors also presented contractions of 0.5% and 1% respectively.

Today’ third release of GDP for the second quarter of 2012 brings more good news. The economy did not contract as much as previously thought. In fact, we have had positive surprises with each Q2 GDP release and this probably reflects the uncertainty that the Diamond jubilee and some pretty atrocious summer weather threw up over statistics.

Since the initial data release ONS have been able to use survey data and other administrative sources to revise their GDP estimates, thankfully they all contributed to upward revisions. The charts below show the consistent upward revisions to all output measures over the past couple of months. 
 

Past data is also subject to revisions and in today's release there is more good news relating to growth last year. GDP in the second quarter of 2011 was revised up from a contraction of 0.1% to growth of 0.1% which brings GDP growth in 2011 to 0.9% up from the previous estimate of 0.8%.

Business and Manufacturing investment for 2012q2 were also revised up quite significantly. 
 

These manufacturing investment stats provides a bright spot in current statistics. They show manufacturers are looking through the economic cycle and are investing despite current difficulties securing orders and the global uncertainty with which they are dealing.

From our perspective the government needs to capitalise on this and do all that it can to build further on this investment momentum in the coming months.

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.

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.