UK manufacturing takes a good dose of global risks in 2015

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Today’s IoP wraps up the data from a challenging year for UK manufacturing. After growing by a solid 2.7% in 2014, the sector saw a marginal contraction of -0.2% over 2015 as a whole. The year ended very much like it started with manufacturing output drawing near to a halt in Q4. This was interrupted by two quarters of negative growth in Q2 and Q3, leaving output broadly the same as in 2014.

 

The writing’s on the wall

We saw the writing on the wall in late 2014; back then, headwinds started building up in the sector with the slump in the oil price hurting demand in oil & gas related sectors. These headwinds fully manifested themselves in 2015 – and then some. The combined collapse of global commodity prices and the slowdown in China sent ripples throughout the world economy.

As our Exec Survey 2016 shows we are likely to see these headwinds persisting well into 2016; there are no clear indications that the rollercoaster of risks is likely to abate anytime soon. This means we are bracing ourselves for another challenging year for UK manufacturing. Nevertheless, manufacturers are not sitting on their hands nor all sectors are experiencing the same conditions.

 

It’s a global story

In many ways the fortunes of UK manufacturing – and its different sectors – have been shaped by three interrelated global economic phenomena. That is, the collapse in global commodity prices, the settling in of deflationary pressures, and subdued export demand. These can help explain sectoral variation within UK manufacturing which emerged as a key theme throughout 2015.

 

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1. The end of the commodity super-cycle

The commodity supercycle that lasted for almost two decades came to an abrupt halt in 2015. The massive fall in oil prices – precipitated by a change in supply-side dynamics – and the slowdown in China’s industrial sector cutting off the key source of demand for raw materials sent global commodity prices on a downward spiral.

This spelled bad news for sectors embedded in the UK oil & gas sector, as well as more manufacturers in more commoditised industries. Cancelled or postponed investments in the North Sea saw mechanical equipment bear the brunt, while the electrical equipment sector did not emerge unscathed either. 

The slowdown in China’s industry also left steel manufacturers there with a large supply overhang.  The subsequent flooding of world markets with cheap steel – along with a mix of other factors, such as high energy prices – caused a sharp deterioration in the competitive position of UK’s steel makers, leading to large falls in output and job losses in the sector.

On the other hand, sectors that use raw materials as an input into production have seen a boost from low commodity prices. The chemicals industry – where oil is the most significant input cost – saw output grow at a rapid pace for the second consecutive year. The rubber & plastics sector also benefited from lower input costs, however this was offset by weaker-than expected growth in construction – the sector’s largest market.

  

2. Hello deflation

The slump in global commodity prices has also spurred deflationary pressures throughout the global economy. The UK’s inflation rate for 2015 came at 0%, the lowest level in more than 60 years. This has had a net positive effect on UK manufacturing sectors vis-à-vis increased consumer spending.

No other sector better exemplifies this trend than motor vehicles. The production of motor vehicles saw a large boost from the increase in consumers’ disposable incomes, both in the UK and abroad, with real wages rising and petrol prices falling. As a result, the sector continued to march on its robust growth path in 2015 too.

Not all sectors have managed to capitalise on higher consumer demand however. The food and drink sector has seen price deflation exacerbated by the supermarket wars, with ensuing pressure on margins taking its toll on output.

 

3. Goodbye export demand

Global trade growth in 2015 posted its lowest pace of growth since 2009. Naturally this is not a positive development for the export-intensive manufacturing sector. Low demand from key emerging markets – centred but not limited to China – has piled on the pain for sectors negatively affected by low commodity prices, as well as weighed on the prospects for sectors that have otherwise seen solid growth.

Low demand is not solely an emerging market story either; 2015 was another year of lacklustre demand from the Eurozone. An appreciating sterling aggravated this trend, with exports to the UK’s largest single market failing to provide much support to the manufacturing sector.

Nevertheless, there are some sectors that have remained immune from these global forces. The other transport and pharmaceutical sectors are largely shielded from fluctuations in demand and prices. The former continues to benefit from large backlogs and innovative production processes, while the latter has finally moved off the patent cliff, posting growth for the first time in seven years.

 

So what’s in store for 2016?

As we said at the outset, these global dynamics are set to persist in 2016. This means that the headwinds that weighed on manufacturing growth prospects in 2015 will continue to pose a challenge for the sector. But with challenges also come opportunities.

Manufacturers look intent to continue investing in teasing out those productivity gains, as well as cracking along with their innovation plans to create new demand. They are likely to protect their businesses from escalating risks by upping their efforts to improve their competitive positions.

For a more comprehensive view of UK manufacturing’s prospects in 2016, look out for our Q1 Manufacturing Outlook published on 7 March.

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