Eurozone problems spilling into orders, highlights the need to focus on growth

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Today's economic data release on UK GDP growth in the third quarter showed a modest upside surprise. But the simultaneous Manufacturing PMI 28 month low doesn't bode well for the remainder of the year.

The GDP result was ahead of most analysts' expectations of a 0.3% rise, mainly on the back of stronger growth from business and financial services.

Manufacturing grew too; though at a modest 0.2%, which only equalled the performance of the weak second quarter. And the fourth quarter seems to have opened even more weakly with today's 47.4 PMI reading indicating contraction in October.

Most concerning in the PMI data is the dive in the new orders reading reaching 44.

So what's driving this?

Weakness on the domestic side of the economy is the result of well-known factors. The drag on consumption continues from high inflation, a weak housing market, and high unemployment.The contraction in government spending seems to be showing up most clearly in terms of the number of public sector jobs with some reports suggesting the OBR's initial forecast may be too light.

These weaknesses remain with us.

The major change since the start of the year, when manufacturing was growing strongly, is the weakening in external demand.

We have increasingly heard from manufacturers saying the continuing problems resolving the eurozone debt crisis were causing firms, particularly SMEs, to hold off investment and recruitment.What today's PMI suggests is that the uncertainty and doubt on the strength of future demand that the crisis has created is now spilling into customers' orders. Worryingly this seems to be impacting markets both within and outside Europe.

As concerning as this is, we still expect growth in the sector to return particularly as demand from emerging markets strengthens. For example, though coming from a low base, quarterly goods exports to China have increased 16% in the 3 months to August 2011 compared with the 3 months to August 2010. These are growing markets.

In the medium term manufacturing is still at the heart of an economy characterised by a greater reliance on trade and investment as sources of growth.

But what today underlines for us is that clearly growth cannot be taken for granted. Europe still accounts for half our exports. And the seriousness of the debt crisis is reaching much further afield.For this reason we consider more than ever the government must use its Autumn Statement to provide a much stronger focus on growth.

The government cannot decisively change the situation in Europe but it can offset manufacturers' caution regarding investment by introducing 100% capital allowances for two years.

The government can also match its action with its rhetoric by getting serious about growth enhancing policy reform, especially in terms of reducing the burden of taxation and regulation and increasing the flow of finance and skilled workers - see our blogs for more detailed suggestions.

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