This morning we released our EEF/Santander Investment Monitor 2016 report. Our survey comes at a time when economists are still struggling to pinpoint the impact of the Brexit vote on the real economy. While the strong Q3 GDP data has appeased some of the worries about a post-referendum collapse, the outlook for investment remains far more uncertain. The fact that official data on manufacturing investment is released as late as December 2016 is further complicating matters.
Fortunately, we don’t have to wait that long. Our report offers insight into manufacturing investment intentions in the post-Referendum period. And manufacturers’ investment plans will have a substantial bearing on the investment momentum of the economy as a whole; the manufacturing sector punches above its weight on investment, responsible for 14% of all business investment and 67% of all business expenditure on research and development (R&D) in the UK.
What’s more, the report provides survey evidence from March and August, the periods preceding and succeeding the EU referendum. By comparing these two datasets we can identify with some degree of confidence the change in investment intentions in the manufacturing industry as a result of the Brexit vote.
So what’s happening with manufacturing investment?
The results of our survey show that after healthy capital spending for the past few years, manufacturing investment in capital equipment is set for a slowdown over the next two years. Before the alarm bells go off, this does not mean that manufacturers are canning their capital expenditure plans, but rather, that they’re investing at a slower pace compared to previous years.
Our time series data shows that the proportion of manufacturers spending the same or less on plant and machinery over the next two years has crept up steadily from 51% in 2014, to 54% in 2015 and 60% in March 2016. The proportion of manufacturers spending a higher percentage of their business turnover – 25% or more – has gone the other way, halving to 5% in 2016 from 10% back in 2014.
What’s driving the slowdown?
The results are underpinned by two key drivers weighing on overall investment levels; demand uncertainty in the short-term and a changing investment mix over the longer-term:
- Demand uncertainty
If there’s one word to characterise the current macroeconomic landscape that’s uncertainty. This is a key theme for our Investment Monitor survey too. Order book uncertainty is the top reason weighing on manufacturers confidence to invest over the next two years. In our March 2016 survey, around 43% of manufacturers cited order book uncertainty as a reason for not increasing investment, compared to 21% in 2015. A persistently soft demand environment is not helping either, with about a third of manufacturers experiencing a degree of spare capacity in their business. This means they are unlikely to invest heavily when their existing capital is under-utilised.
2. Change in the investment mix
Strong investment in plant and machinery over the past few years is prompting manufacturers to shift their focus towards investments capable of giving them a competitive edge in tough markets conditions. A good way of doing that is through investment in innovation; this can help manufacturers increase their share in product markets and secure future demand, as well as improve overall productivity. The proportion of manufacturers agreeing that investment in intangibles is becoming more important than spending in plant and machinery has grown exponentially in our survey, from 31% in 2014 to 60% in March 2016.
Any movement since Brexit?
We’re seeing little impact so far of the Brexit vote on manufacturers’ investment intentions over the next two years. When comparing the results with our March survey, conditions for manufacturing investment are mostly unchanged. This shows that the Brexit vote itself has not prompted the majority of manufacturers to change the short-term investment plans they put in place at the beginning of the year.
However, that doesn’t mean that all manufacturers are looking through Brexit to press on with their current investment plans. Nor does it mean that manufacturers are unlikely to scrap existing or new investments further into the two-year time horizon of the survey. Rather this indicates, that at present, a slowdown in investment continues to be the most likely outcome over the next two years, as opposed to an outright collapse in manufacturers’ investment intentions post-referendum.
What’s driving the resilience?
While at first glance the results may seem counter-intuitive, looking at the underlying drivers can shed some light around this resilience. A range of factors are playing a role to sustain manufacturers’ short-term investment plans since the referendum.
First and foremost, our survey looks to identify investment intentions in the manufacturing sector over the next two years. This means that the time horizon falls well within the expected negotiation period between the UK government and EU institutions and well before the UK’s actual withdrawal from the EU. Manufacturers cannot press the pause button on their business until the UK’s future relationship with the EU is sorted out.
This is also true in terms of their capital investment; while they will be spending less on kit, they can’t allow their existing capital to wear out. Nor can they stay idle in the face of demand uncertainty; manufacturers are looking for ways to grow their sales by innovating and diversifying into new markets.
But political uncertainty spikes
So, overall investment levels and the key drivers behind those are broadly unchanged between our March and August surveys. However, there is one key movement. Political uncertainty has more than quadrupled to 21% from just 5% in August, to record the highest level in the history of our survey. This is inevitably adding another layer of complexity to manufacturers’ investment plans.
Moreover, the demand outlook has shifted somewhat. Manufacturers are now considerably more optimistic about the export outlook, with stronger demand from key exports markets and the depreciation of the pound, providing a shot in the arm to exporters. Conversely, the outlook for the domestic demand environment has moved further into the red.
Summing it up
The results of our survey suggest that manufacturing investment in plant and machinery is in for a slowdown over the next two years. Elevated levels of uncertainty are clouding the ability of businesses to forecast future demand and therefore their confidence to proceed with large-scale investments.
The referendum result has not changed this underlying trend; manufacturers’ investment intentions post-referendum are broadly in line with where they were back in March. Manufacturers still need to invest to have the capacity in place to fulfil existing customer requirements and satisfy current demand.
However, while the referendum did not prove to be the trigger for a change in manufacturers’ short-term investment behaviour, that doesn’t mean that we’re out of the woods just yet. There is a range of potential trigger points likely to surface over the next two years, with the activation of article 50 or the location of a multinational’s next round of investment, featuring high on that list.
In any case, lack of visibility around these trigger points means manufacturers are likely to refrain from any investments that fall outside of fulfilling current customer needs within this two year time-horizon. And while our survey points to hesitation among manufacturers to invest heavily even before the referendum, any marginal investment decisions are less likely to get over the line after the Brexit result.