Today’s inflation report brings a more positive tone to the future outlook than has been seen for a while, with both the output and inflation forecasts having been revised in a positive direction. The improvement was driven by signs of early momentum picking up in the wider economy. We look at some of the reasons behind each of the revisions in turn.

Output forecast revised up

The upside surprise of 0.3% growth in the first quarter of this year underpins a number of other indicators that give rise to the expectation of stronger GDP growth over the course of this year. Demand and supply are expected to pick up gradually with a number of factors contributing to this change in view. While employment has fallen back somewhat, it is expected to pick up more than previous estimates, household real incomes have led to some up-tick in consumption and the extension to the Funding for Lending Scheme is expected to ease credit conditions and boost demand.

Risks do remain, however, and the recovery, though slow, will depend on how households and businesses respond. The international environment will continue to weigh on sentiment, particularly those risks pertaining to the Eurozone.

Inflation forecast revised down

In the past couple of months inflation remained sustained but for the first time in a while the forecast has been revised down though it will still take the best part of two years to return to target. The slow return to target is expected as administered and registered prices are to remain elevated.

The improvement in the overall forecast was driven by expectations of external price pressure being lower and higher labour market participation dampening down domestic pay pressures.

All in all, the picture is somewhat more positive but the overall trends are not much changed. Inflation will continue to remain above target for some time and, while the economy will remain subdued, it will be growing. As we have mentioned in an earlier blog we want to see the government doing everything possible to support growth, by providing more certainty to business that they have a plan get the economy growing again and ensuring decisions, such as the upcoming spending review, do everything possible to support growth.

Over the course of the next two months the government will be making some difficult decisions as they set budgets for 2015/16 as part of the 2013 spending review. Departments along with representation organisations like EEF are in the process of developing recommendations and feeding into the Government’s decisions process.

It is difficult to consider spending decisions in 2015/16 without taking into consideration the current economic climate. The current economic and fiscal context, with all the risks and challenges that that entails, will have a bearing on the path of public finances and economic growth. Ignoring this context is risky.

The context

The most recent GDP data provided a much needed positive surprise with growth coming in and 0.3% in the first quarter of 2013. That said, taking a longer time perspective makes it clear that the economy has shown little signs of growth for the past 18 months. With a lack of demand permeating the UK economy, investment and trade continue to struggle and the task of rebalancing the economy looks as daunting as ever.

Public finances are similarly grim – the lack of growth along with the government’s budget and consolidation decisions have delayed public finances getting back to a more level footing. Given this, as we think about the implications of setting budgets for 2015/16 in the upcoming spending review we can’t help but question the appropriateness of the government’s fiscal framework and the path of consolidation that has been set. At a time when stimulation in the economy is severely lacking, consolidation has held growth to a much lower path than it otherwise would have been and there is more to come.

With challenging economic conditions the focus needs to be on growth

Unfortunately in the current environment there are no easy choices so the government will need to make some trade-offs. The good news though is that there are options available and the fiscal framework set out by the government does afford some room to do more for growth.

Sticking with the current plan will continue to restrict growth. While providing a clear path for reducing the deficit, the implications of the current spending limits for departmental spending and for growth are large. Departments have already undergone significant cuts in previous spending reviews and further cuts are likely to make it difficult for departments to achieve the outcomes set for them. The current path also means government will continue to drag down growth.

Growth can be stimulated by more capital spending. Capital spending has the highest growth multiplier so the most significant and direct impact the government can have on growth is by increasing capital spending. Living within the spending limits set in Budget 2013, however, would require additional savings so more capital spending could be financed by reprioritisation and the government would also face the challenge of deploying additional funding quickly.

Relaxing the ring fences will ease pressure on budgets that are important for growth. Health spending has been one of the fast growing areas of government for the past decade and has not been placed under the same pressure as other departments despite large potential for savings. Research by the OECD suggests that public health spending has the potential to make the most significant contribution to consolidation without harming health outcomes.

It is not just about spending; the UK needs an overarching growth plan to drive decisions

Spending decisions should form part of a concerted action by government to drive more growth. A long term strategy for manufacturing was identified by 53% of manufacturers as one of the top three changes that would encourage more investment in the UK. EEF’s Route to Growth sets out our view on an industrial strategy that would provide greater certainty in the policy environment that businesses seek.

The government’s fiscal strategy also needs to be guided by a focus on growth. We think this means continued commitment to bringing down the deficit, more funding prioritised towards growth and spending areas that are vital for the long-term competiveness of the UK being protected.

Our full spending review submission will be published in the coming weeks. Stay tuned for more.

Last week we had the good news that GDP didn’t contract, and in fact actually grew 0.3%, in the first quarter of 2013. While these numbers are positive, we can’t get away from the fact that there remains little underlying expansion and a lack of demand in the economy as a whole at this time. While this is expected to pick up over the course of the next couple of years, we can’t help thinking what more can be done to get the economy growing and rebalancing now.

In a survey we ran last year we asked manufacturers about their investment over the past few years and their investment plans going forward, and the barriers they face when investing. We also asked manufacturers the very question posed above. Specifically we asked manufacturers – what policy change would lead the company to increase the level of investment in the UK?

An Industrial strategy would have the biggest impact on investment in the UK

Perhaps not surprisingly, greater certainty in the policy environment would have the biggest impact on manufacturers’ investment in the UK. The investment cycles generally spans multiple political cycles so greater confidence over aspects of the business environment will lower the risks of an investment being unprofitable.

• 19% of manufacturers said a long-term strategy for manufacturing would have the biggest positive impact on investment in the UK.
• 53% said it was among the top three changes that would positively impact investment in the UK.

An industrial strategy needs to be based on a wide range of policies that matter for business

An industrial strategy needs to be informed by businesses priorities and needs to focus on getting the policies that affect investment incentives right for the broadest possible base of businesses. The chart below shows the top five policy changes that would have a significant impact on investment in the UK.

• The tax system is both an enabler and a barrier to investment. Making sure the country's taxes work, as much as possible, to promote investment means the government has many tax levers available to encourage greater investment, including, but not limited to, capital allowances, the R&D tax credit and the overall burden of tax.
• The finance environment has been changing since the financial crisis and is restricting the ability of firms to finance investments. Over a third of companies report they have viable investment going unfunded because of difficult credit conditions associated with external finance. The government could do more to encourage greater competition in the banking sector to improve credit conditions for businesses.
• The government has an important role in ensuring the economy has, and will continue to have, the right mix and supply of skills to support a growing and rebalanced economy. Four in five manufacturers report having problems with recruitment.
• UK companies face higher energy costs than most of our key competitors, putting us at a disadvantage. Government policy has had a greater impact on energy costs in the UK than elsewhere.
• The UK does not tend to innovate quite as successfully as other countries despite a strong science and research base and many highly innovative individual companies. The balance of government support is weighted towards early-stage research and the government could do more to help companies convert basic research into products and services that will make a profit.

As you can see, the policies that are important for manufacturers are broad and are not specific to the manufacturing sector. There is no single action or lever that will deliver the large shift in investment that our economy needs. Rather the government has a role in providing clarity and certainty about its priorities along with concerted activity to reform the policies that will support the widest group of companies to invest.

More information and research can be found in EEF’s report Invest for Growth, encouraging more globally focused companies to expand in the UK.

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.

The Decision

Bank rate held at 0.5%

Stock of asset purchases held at £375 billion.

The Discussion  

Financial markets

• Relatively limited reaction from financial markets to Cyprus bailout
• Equity markets continued to be buoyant, some major international equity indices at all-time nominal highs
• Little reaction to UK being placed on negative watch by Fitch

International economy

• Global growth continues to show gradual recovery with world trade and investment  picking up in early 2013 but pattern of growth remains uneven
• Tentative signs of strengthening confidence in the Euro area have  not been maintained
• US indicators positive with robust consumer spending, a strong housing market and growing employment despite more restrictive fiscal policy.
• Asia still showing evidence of expansion with Chinese PMI rising in March and business confidence improving in Japan.

Money, Credit, Demand and Output

• Turning to the UK, there is mixed news of activity in the first quarter of 2013 from official indicators
• Credit conditions have eased with the supply of credit increasing and some feed through in loan rates. However small companies continue to report more difficulties accessing finance and there has been little sign that easing of credit access has fed through into higher net lending to businesses.
• There is some evidence of increased supply of credit feeding through into the housing market.
• The committee agreed that a well-capitalised banking system is important for the capacity of the economy over time and saw merit in boosting lending through an extension to the FLS.

Supply, Costs and Prices

• Inflation expected to remain high, rising to 3% in the middle of the year
• Pay growth has continued to be weak
• Productivity remains puzzling as employment continued to increase despite falling output. Relatively low company failure due to low nominal interests rates and forbearance by lenders was discussed as one of the factors contributing to low productivity.
  

Some facts 

• In 2012 the Electronics sector contributed around £8.2 billion of output to the UK economy.
• Electronics makes up almost 6% of UK manufacturing. 
• The sector employs around 138 thousand people, who work in over 6000 thousand electronics firms. 
• Manufacturing companies in the UK electronics sector range from small contract manufacturers to full scale semiconductor production.

Today we published the first edition of Manufacturing Outlook for 2013 which shows that Britain’s manufacturers have endured a tough start to the year. Trends seen in the past three months once again point to a struggling manufacturing sector but the view ahead is somewhat rosier.

Looking back:

Output and orders remained low as expected

For the second quarter in a row and in line with expectations, output and order balances remained around a three year low. Demand conditions remained difficult across a number of markets which is feeding through into poor orders from both the domestic and export markets. Europe continues to stand out as an especially challenging market with sluggish demand dragging on export growth.

Output and orders, % balance of change in the past three months

Looking forward:

Signs of a more positive quarter ahead

Our Business Trends survey results provide some signs that manufacturers may see conditions start to turn around during the next three months. Output and order balances are expected to recover back to the levels seen in the early part of last year, with companies planning for growth in both export and domestic orders. Notably, there has been a big improvement in the proportion of companies that are planning for growth in overseas markets in the next three months, a trend which, importantly, is fairly widespread across most manufacturing sectors.

This forecast improvement in trading conditions in the three months ahead can also be seen in manufacturers' business planning. Manufacturers are planning to increase their employment levels in the next three months and they are looking to raise their capital investment over the next 12 months.

Investment plans, % balance of change

While the UK needs this positive news, particularly in a time where growth driven by trade and investment remains to be seen, a recovery cannot yet be taken for granted. As outlined in EEF's report The Route to Growth, we need to see a more concerted effort by government to boost growth and to provide the stability and certainty that businesses need to put their strategic plans and investment into action. The Budget, in a few weeks time, will be a good place to start.

The need to build supply chain resilience has been rising in prominence. This is not a new issue and we have previously blogged on how, in an uncertain world, manufacturers are managing the risk of disruption and are employing a range of methods to respond. In a workshop on Managing Global Supply Chains yesterday, part of EEF’s Manufacturing Conference, we heard three companies comment on what they are doing to improve their understanding and reduce the risk of supply chain disruptions.

• Mark Adams from Toyota Motor Europe spoke about how they are working with suppliers to improve competitiveness.
• John Hammon from SAP outlined some of the tools available for gathering and analysing supply chain information.
• Ian Metcalf from Brother discussed how supply chain mapping and the right information can help companies be more responsive to changes in demand.

Some key take-outs from the discussion:

Collaboration can help overcome some of the key challenges facing manufacturers

• Key challenges today’s manufacturers face include distance to market, length of the supply chain, speed of innovation, price competitive markets, exchange rates, the need to have a global view of business, and communication.
• Toyota Europe works with suppliers to teach them LEAN manufacturing techniques and to solve problems facing the sector. Through mutual support they aim to reduce waste and lower costs, a move which is important in a market facing price wars, low margins, over-capacity and recession. 
• In question time, panel members made it clear that the aim of collaboration must be to maintain and improve competitiveness. Disclosure is an important part of mapping a supply chain.

Technology, if used correctly, can help manage supply chains and make manufacturers more responsive and flexible

• Technology can be used to improve standardisation, facilitate operational comparisons and improvements in operational efficiency, and support faster reporting and decision making.
• SAP analysis shows that the best supply chains score 37% higher on time delivery and have 89% lower inventory carrying costs.
• Social media is newer technology that can speed the process of feeding consumer responses and perceptions back into the manufacturing process.
• Brother found using the right technology to combine supply chain information allowed them to make smooth adjustments to production and communicate changes along their supply chains. Better visibility of demand and supply chains allowed them to more responsive to changes in customer demand during the financial crisis than competitors.
• Technology is not the answer in itself and should be used to support good processes. Supply chain processes are complex and technology can help understand and information to make managing them more effective. 
  

Today EEF has released its latest report Invest for Growth - Encouraging more globally focused companies to expand in the UK. The report, which includes the results from a new survey on manufacturing investment, paints a picture of a strategic sector that faces a number of challenges in turning their plans into concrete actions and investment.

Manufacturers are ambitious

The survey clearly shows that manufacturers have strategies and plans in place to expand and grow. Most manufacturers have a strong focus on bringing new products and services to new customers and in new geographical areas. These priorities have been driving firms to increase their capital investment, which in turn is making them more profitable.  

• Nine in ten firms are planning to invest to improve productivity, three-quarters to adopt new technology and seven in ten to develop capacity to manufacture new products in the next 12 months.
• Half of companies increased their investment in the last three years and only one in ten reduced it.
• Investment is being made not just in modern machinery but also in skills, R&D, marketing and innovation.
• A balance of half of companies increasing their investment reported increased profitability compared with 7% who decreased their investment.

But there are concerns investment is not high enough

Despite these positive plans and recent trends, manufacturing has suffered from a decade of declining investment, which saw pre-recession investment levels fall below that of our competitors. The recovery in business investment has also been slower than our competitors leaving it, still, 14% below its 2008 peak. The survey results reflect these challenges and shows that the falling investment has damaged competitiveness and investment is not as high as manufacturers would ideally like it to be.

• A fifth of manufacturers feel they are falling behind their international competitors.
• A third said the gap between what they want to invest and what they actually invest is growing.

Closing this gap will not be easy

The challenge of attracting and retaining investment is not unique to the UK. In an environment where more and more manufacturers have production facilities overseas, they must weigh up the pros and cons of different investment locations. Overall there is a shift towards more investment taking place overseas.

• Some 80% of companies with current facilities are planning to invest abroad whilst 15% of companies with no current production facilities abroad are planning investment outside the UK in the next three years.
• Two-thirds of survey respondents said proximity to customers was one of the most important factors when deciding on investment location, with labour costs (34%), skill availability (23%) and proximity to suppliers (17%) also important.

Manufacturers must also overcome a number of hurdles when it comes to investing. Demand uncertainty was the most cited reason for companies choosing not to go ahead with an investment and lack of strategic importance also featured. Finance is also a big challenge as investment decisions often come down to whether there are sufficient funds available; both access to adequate external finance and having sufficient available internal cashflow are holding back investment.

• The biggest barriers to investment were demand uncertainty, lack of cashflow, the desire to pay down debt, and tax and pension fund liabilities
• Smaller firms in particular struggle to access the external finance they need for investment, with 47% saying they have investment plans going unfunded because of availability, cost or the terms and conditions on external finance. 

The Government has a clear role in promoting investment

The Government can greatly improve the attractiveness of the UK as a place to invest and grow a business by reducing the uncertainty around key aspects of the business environment. At the heart of a more predictable business environment must be a long-term strategy that focuses on manufacturing.

• 53% of companies said a long term strategy for manufacturing would have the biggest positive impact on investment in the UK.
• This industrial strategy must provide certainty of a spectrum of policies including a competitive tax system for all companies investing in the UK, improved access to external finance; increased availability of suitably qualified staff; competitive energy costs; and more support to commercialise technology.

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.