UK manufacturing in recovery mode | EEF

UK manufacturing in recovery mode

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Our final Manufacturing Outlook survey for 2016 points to early signs that a recovery in manufacturing activity is underway. All our key indicators are back in the black with output and orders balances returning to positive territory for the first time since 2015q2.

This improvement has jolted confidence in the sector, prompting manufacturers to step up their investment and recruitment activity. However, the good news is tempered by another weak quarter on exports and a continuing squeeze on margins.


What are the key findings?


In last quarter’s Manufacturing Outlook we flagged that manufacturers expected a recovery in the sector to materialise in 2016q4. Not only has this prediction proven to be accurate, but the results have exceeded previous quarter’s expectations by some margin.  Both output and orders balances rose to 13% from -7% and -4% respectively last quarter, reaching highs that have eluded our survey over the past couple of years.

 An overall improvement in trading conditions has injected a good dose of confidence in the sector which continues to gain ground following the sharp falls in the aftermath of the referendum. Although still below pre-referendum levels, confidence about the UK outlook made some solid gains, no doubt a consequence of the larger than anticipated pick-up in domestic sales this quarter.


Manufacturers press the play button on investment and recruitment

Expanding production, a better demand outlook and higher confidence about economic prospects over the next twelve months has prompted manufacturers to unfreeze investment plans after a full year of negative prints on the capital expenditure balance. Manufacturers are likely to be investing in some extra capacity to capitalise on an increasing order intake, as well as taking on more staff to man their busier production lines.


 This picture is backed up by our recent Investment Monitor report which showed that despite the uncertainty overhang in the economy, manufacturers recognise the need to invest to satisfy current customer demand.


Export boost gone missing

You might have noticed in the key findings table above that amidst a flurry of upward pointing arrows, there’s one pointing the other way – export orders.  The export order balance dipped to -2% in Q4 after a positive print last quarter bucked a trend of four consecutive quarters in the red.

This suggests that the pass through of the pound depreciation on export orders – down 20% against a basket of major currencies over the year – has so far been incomplete.


But it’s just around the corner

We have reason to believe this is temporary. First, the export orders balance for the next three months has jumped to 15%; if this materialises it will be the highest balance since Q1 2014. If you are an EEF blog regular you will recognise this as roughly the point when global headwinds – like the drop in global commodity prices and slowdown in our key export markets – emerged thick and fast to hit UK manufacturing activity.

Second, manufacturers have consistently reported better demand conditions from abroad over the course of the year, especially from Europe and North America.

What’s more, the full impact of the pound depreciation should start to feed through to most manufacturing sectors in 2017. While more commoditised sectors have already seen some of the benefit, mostly through an import substitution effect, the less price-sensitive high value-add sectors are yet to feel the boost.

Expectations of a continuing improvement in export demand and the benefit of the lower pound filtering across most manufacturing sectors should support export activity in the year ahead.


As is inflation however…

But there’s a flip side to the pound depreciation, something that EEF has gone at pains to emphasize in the past few months. The integrated nature of global supply chains means that the UK manufacturing sector is largely dependent on imported materials and components. The depreciation in Sterling makes all these more expensive, increasing productions costs and depressing margins.

Indeed the fly in the ointment for our Q4 survey is ballooning input costs making it increasingly hard for manufacturers to squeeze out profits. This is especially the case for import-intensive manufacturers who cater primarily to the domestic market; they will be unable to offset the pressure on domestic margins through higher export sales, as evidenced by the UK margin balance plunging to its lowest level since 2009q3.


The picture on export margins is more positive, although the negative balance for the next three months (-1%) indicates that manufacturers are unlikely to be able to fully offset higher production costs by propping up export prices.

A further implication of this trend is that higher imported prices are expected to bite on household consumption too, as the pass through to higher CPI inflation starts to erode consumer disposable incomes. The balance on UK orders for the next three months has halved to 6% from 13% this quarter, reflecting the anticipation of lower demand for consumer-facing products.


What does this sum up to?

All in all, the results of our survey reveal a considerably more upbeat picture for the manufacturing sector at the end of 2016. A still resilient domestic market, a forthcoming export boost and a more solid footing for investment and employment are undoubtedly positive developments.

Nevertheless, these first signs of recovery remain tentative and as we move into 2017, the risks – Brexit and non-Brexit related – are plenty and widespread. Exchange rate volatility, inflationary pressures, a slower domestic market and caution over investment will keep manufacturers on their toes in the year ahead.  

Encouragingly, the sector appears better positioned to deal with these challenges compared to the start of the year. We expect the sector to contract only slightly in 2017 by -0.2% after an expansion of 0.2% in 2016 as a whole.

If you need (even more) detail on the survey findings, you can access the full report here.


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