EEF blog

For manufacturers, 2011 was a year of significant upward pressure on input costs.

But in the last couple of weeks, data releases on consumer prices and producer prices would suggest that inflation is now starting to come off the boil. The year to December saw the slowest annual increase in producer input prices since October 2010.

High and volatile input prices can cause significant problems for manufacturers, so it is good news that price pressures are starting to ease. However, since the global recovery began, another problem has emerged: that of availability.

Over 80% of manufacturing executives said that a shortage of raw materials was a significant risk in 2012.

Our survey of manufacturing executives found that concern about the availability of raw materials is pervasive, across all sizes of business and industry sectors. In fact raw material shortages are such an issue that two thirds of companies saw this as the top risk to their business plans in the year ahead – considerably more than any other issue.

Why is this?

While some risks may dent growth, or cause less concrete knocks to business, being able to business, being unable to secure or fulfil orders, or having to run below optimum capacity are real and tangible outcomes that can arise quickly when there is a lack of raw materials. 

Outlook for prices and availability

Slower global growth as a result of the Eurozone crisis and the Chinese government’s attempts to engineer a ‘soft landing’ may have abated pressure on input prices, but availability and price of specialist materials such as metals and rare earths remain an issue.

The weaker economic outlook may alleviate commodity prices, but with global demand for inputs continuing to rise, the issue of raw materials prices and shortages is set to be a perennial one.

Today’s producer prices data reflect what surveys such as the PMI have been pointing to for the last few months: input price rises are starting to ease. 

Although prices were still up by over 14% in the year to October, this was the lowest annual increase since December 2010. What is more, between September and October prices actually fell back a little, mainly reflecting price falls in crude oil, imported metals and home produced food.

This will provide some comfort for the Monetary Policy Committee, which has argued that consistently above-target inflation has been largely caused by external pressures that should start to abate in the next twelve months.

Based on this view, the MPC announced yesterday that it would keep the base rate on hold at its record-low level of 0.5% and continue to add to its stock of asset purchases up to a value of £275bn over the next three months. This loose monetary policy also reflects the MPC’s belief that demand – at home and abroad – will be so weak as to risk inflation falling below target in the medium term.

But these arguments are disarmingly similar to those we have heard from the MPC from some time. And inflation has remained high. In December inflation will have been above the MPC’s target rate of 2% for two years.

Ahead of the Bank’s Inflation Report next week, here is a quick overview of what’s kept inflation above-target:

Two years of temporary factors

1) VAT

The two increases in VAT, in January 2010 and January 2011, both had a year-long impact on the figure for CPI. This effect will fall out of the figures in January 2012.

VAT has a significant impact on consumer prices

12-month % change in CPI and CPIY (CPI excluding indirect taxes)

Source: ONS, 2011

2) Exchange rate depreciation

Though its impact was less marked this year than in 2010, the depreciation of sterling which started in mid-2007 added significantly to the cost of imported goods, thereby feeding through into consumer prices.

In the past year sterling exchange rates have been much more stable, and though high levels of uncertainty in Europe mean that this could change, there is no particular reason to think that sterling will drop significantly in value, as most commentators now believe the currency is closer to its true value.

3) Commodity price rises

As I have pointed out, pressure on producer prices has started to abate in the last few months. Weaker global demand would point to this trend continuing.

Although previous energy price-rises meant that energy providers have recently passed on big price rises to their customers, even this should work its way out of the inflation statistics by September next year.

Producer prices have stabilised in recent months

Producer Prices Index, Input Prices (2005=100)

Source: ONS, 2011

This week, in partnership with RBS, we’ve launched our latest publication series, Manufacturing Focus.

Manufacturing Focus is a twice-yearly publication focusing in-depth on current issues of importance to manufacturers. Our first issue looks at managing materials prices - something that's been in the news a lot in the year so far.

Why is this such a big deal to manufacturers?

Because materials constitute a large proportion of manufacturers costs – often over 50% and for some as high as 80%.

And what we’ve seen over the last 18-24 months (perhaps further if you include the period pre-financial crisis) is an environment where prices have been quite out of the ordinary.

Firstly attention was focused on strong rises that gathered pace in 2010 and spilled over into 2011 – well over 50% year-on-year price increases for many key industrial inputs. For one electronics manufacturer, a basket of rare earth metals have increased an astonishing four to six fold.

Rising prices have had consequences not just for producers but consumers too and this can be seen in the correlation between input prices and both export and domestic price increases, as shown on the below chart (industrial materials index RHS, balance of companies reporting increase in prices LHS). Indeed given the increase in their own costs its remarkable manufacturers' have not increased their own prices more than they have.

More recently some drop-offs in prices have fed concerns the global economy may be slowing.

While a global economic slowdown is cause for concern in itself, recent price falls have meant volatility is also proving a challenging issue for manufacturers to manage.

Lags in responses or adjustments to contracts can mean manufacturers wearing the difference on some cost movements.

Managing materials prices is moving up the agenda for manufacturers, with 48% of companies citing managing prices as one of their top three challenge to growing their business (second only to skills shortages as a top three challenge).

This compares with 33% of companies that saw managing price and availability of materials as an issue in 2010.
Availability rates a separate mention this year too with 15% of companies rating it as one of their top three challenges.