Brexit: To blame or not to blame for the slump in manufacturing investment?

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Nothing new to see here in terms of UK GDP with Q4 growth confirmed at 0.7% and output expanding by 1.8% over the year as a whole. Not the fastest growing G7 economy anymore (you can blame Germany for that Philip) but still pretty solid given this little thing called Brexit.

Not much to see in terms of whole economy investment either, with figures showing an unrevised 1.5% decline in business investment in 2016, the first fall since 2009.

Of more interest are the figures for manufacturing investment in Q4 2016. So, what are the key takeaways from this release?

 

1. Manufacturing investment fell…by a lot

Well it’s fair to say that according to the latest ONS figures, 2016 was not a good year for manufacturing investment. Investment in manufacturing fell by a hefty 9.9% in Q4 2016, the third consecutive quarter of contraction. This took the annual figures to -6.5%, the first yearly fall since 2009.  

 

2. What drove the decline?

Sluggish investment was relatively broad-based across manufacturing sectors, with only ‘other manufacturing’ seeing growth in 2016. The biggest falls were in more commoditised sectors, with investment in textiles falling by 22% and metals & metal goods by 19%.

 

 Bus-I-q4-16---sectors

 

The decline in investment was more tempered in other sectors with investment in engineering & vehicles dropping by 10% and chemicals by 6%.  

 

3. Is Brexit to blame?

The knee-jerk reaction to interpreting these figures would be to shout Brexit as loud as possible. However, caution is needed before attributing this contraction solely to Brexit uncertainty. Some of this drop could reflect a paring back after 6 consecutive years of growth in manufacturing investment.

  

Bus-I-q4-16---time-series

 

Our Investment Monitor 2016 (IM16) would partly support this conclusion. Our survey, taken a month after the EU referendum, showed that manufacturers are paring back their investment plans after strong capital spending over the past few years. Over a third of respondents cited “no need for more investment” as the reason.

And our survey points to uncertainty being a significant factor, although not in the way you might think…

 

4. Brexit is not the only game in town

Given the current hype it feels like the word uncertainty should be copyrighted to Brexit. But Brexit is not the only game in town in terms of uncertainty. Our IM16 survey showed that 38% of manufacturers cited order book uncertainty as a reason for not increasing investment irrespective of Brexit. This was no doubt tied to the soft demand conditions that manufacturers experienced at the time with another 38% blaming a worsening demand outlook for lower rates of capital spending.

 

Bus-I-q4-16---IM16

 

5. Two possible explanations for today’s figures

We can identify two possible interpretations for the larger than expected slump in manufacturing investment in the official statistics today. One could be that investment is operating with a lag; manufacturers still had a degree of spare capacity in the last months of 2016 (30% cited this as a reason for not increasing investment in IM16). Manufacturers’ capital spending patterns take time to adjust to unexpected demand shocks – both to the downside and in this case to the upside. So we could see a substantial rebound in manufacturing investment over the next few months as manufacturers put some extra capacity in place to expand output.

But then again we might not, which takes us to the second explanation. This could be that manufacturers remain cautious about increasing investment in the face of this positive demand shock, along the lines of Ben Broadbent’s speech last week. There is likely to be a Brexit and a non-Brexit element to this.

For the former, given that the improvement in demand conditions was largely down to improvements in the external demand outlook (as shown by our Manufacturing Outlook survey) manufacturers could be expecting that the current positive conditions may be short-lived. This is because there is no shortage of risks out there, including the uncertain impact of political developments in the UK’s two largest exports markets, the EU and the US.

 

Bus-I-q4-2016---demand-exports

 

For the latter, according to Ben Broadbent, manufacturers benefiting the most from Sterling’s depreciation might be wary that the Brexit deal – good or bad – will be negative for their business. A good deal is likely to cause Sterling to appreciate wiping out some of the recent gains in price competitiveness, while a bad deal will yield less favourable trading relationships with the UK’s key markets. This lose-lose situation could mean that manufacturers are likely holding back some investment that they wouldn’t have otherwise.

 

6. What does this sum up to?

Today’s figures are hard to stomach and even harder to interpret given the positive signals about the health of the manufacturing sector coming out of business surveys and other official statistics. We think it’s likely to be too early to provide definitive answers about this hefty investment slump in today’s ONS figures.

They could reflect a lag effect or cautiousness or a bit of both. The degree to which Brexit is having a direct – or more plausibly for the moment, an indirect – effect remains to be seen. But we wouldn’t rule out a considerable upwards revision to the Q4 manufacturing investment figures or even, a strong rebound in the first quarter of 2017.

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