EEF’s first quarter Manufacturing Outlook report makes for encouraging reading. After a disappointing 2015 in which the UK manufacturing sector posted a small contraction in output, there are signs that the worst may be over. Here are the top takeaways.
Output and orders bottoming out
The start of 2016 saw the key output and total orders balances up from their six-year lows of late last year but remain in negative territory for the third consecutive quarter. The improvement suggests that the pace of decline in manufacturing has started to ease.
Yet the balances are still weak because of the lingering challenges facing UK manufacturing. In particular, the steel industry is under exceptional pressure from global oversupply caused by Chinese dumping. Also, the low crude oil price is weighing on the demand of North Sea oil and gas companies for investment goods, hurting manufacturers embedded in the supply chain. Furthermore, slower economic growth in emerging markets such as China is dampening their demand for UK exports.
The recent improvement in the output and orders balances doesn’t appear to be a one-off as far as manufacturers are concerned, as the balances of both in the next three months climb back into positive territory.
Europe is the best chance for UK manufactured exports
The news on exports was also a little better. Even though the export orders balance was in negative territory for the third quarter in a row, it seems to have started to stabilise.
The main support for manufactured exports appears to come from Europe. Manufacturers most cited Europe as the region of the world in which they had seen positive demand conditions. The steady recovery of Europe from recession should have lifted demand for UK exports. Also, the depreciation of sterling against the euro since the middle of last year has improved the cost competitiveness of UK exports in the eurozone, potentially supporting demand.
Yet the export environment facing UK manufacturers remains very challenging. A large proportion of companies surveyed saw no positive demand conditions from Africa, Asia, Europe, North America and South America at the start of this year.
Metals struggle while transport outperforms
The story by manufacturing sector is dominated by the impact of cheap steel imports and the low oil price. By sector, basic metals had the lowest output balance in the past three months. Basic metals has been hit by a double-whammy thanks to its exposure to the UK steel industry and the oil and gas supply chain. Yet there’s some hope for basic metals as the drag from the oil price slump on other manufacturers in the oil and gas supply chain such as mechanical and electrical equipment seems to be easing.
In contrast, the transport sector was the top performer, helped by a large backlog of orders in the aerospace industry. Also, sectors linked to the construction supply chain such as rubber and plastics showed signs of improvement. After the construction industry took a turn for the worse in the lead up to last year’s general election, its subsequent recovery appears to be gathering steam.
Manufacturers are signalling that the sector story is set to improve, as the balances for most in the next three months are higher than in the last.
Hiring and investment on hold
Despite signs that output and orders are bottoming out, manufacturers remain cautious about hiring and investing in capital because of heightened global and domestic uncertainty. The recent volatility of stock markets across the world highlights fears about the growth outlook in emerging economies and whether the US Fed’s move to start raising interest rates late last year will prove premature. Also, the upcoming UK referendum on EU membership is potentially adding to the caution.
Hiring was subdued in the past three months. The employment balance was flat after turning negative at the end of last year for the first time in five years. The lowest balances were in sectors embedded in the oil and gas supply chain. Also, basic metals saw a reduction in headcount, highlighting the pressure on the steel industry. Meanwhile, hiring was up in the food and drink sector as the UK’s healthy labour market and low inflation supported domestic demand.
The outlook for hiring is subdued, with the survey showing the employment balance in the next three months falling back into negative territory. Manufacturers are also pessimistic about the prospects for investment. The balance for planned capital expenditure in the next 12 months fell further into negative territory. By sector, investment is weakest in metals but strongest in food and drink.
On balance, manufacturers fared a little better in early 2016 than previously, with signs that the sector has passed its trough and the improvement will continue in the next three months. Yet the heightened global and domestic risks mean that there’s still a lot of caution.