The Q1 Business Confidence Monitor (BCM) shows business confidence recovering back into positive territory, but still very weak, as companies are concerned over their future sales with continued high inflation and interest rates. There are also worries over how tight government fiscal policy will need to be, in the months and years ahead.
The survey results are based on 1,000 telephone interviews among ICAEW Chartered Accountants covering a range of UK sectors, regions and company sizes, ensuring a representative picture of the UK economy. The latest quarterly findings are based on the period 16 January to 23 March 2023.
- Business confidence has improved in Q1 2023, and is now back in positive territory, having been weakened by political turmoil in Q4 2022. But the level is still low, and the trend within the quarter is not strong.
- Reinforcing that, domestic sales growth has eased, with further weakening predicted. Exports are rising more slowly than domestic sales, at a rate similar to pre-pandemic. Export sales growth is not expected to weaken.
- Input costs and selling prices have continued to climb, but their rates of increase are both predicted to moderate. In contrast, wage growth is not expected to slow.
- Employment growth has eased, reflecting the trends in sales. Capital investment continues, but not at a particularly high rate, and weaker growth is expected. Research & Development (R&D) and staff development trends are similar.
- The big challenges remain customer demand and regulations. Transport and financial problems have stabilised, although with some marked sectoral differences. And labour market challenges have eased, although they are still high, particularly in Transport, Manufacturing, Construction and Retail.
- Once again, Construction and Property are the least confident sectors, while Manufacturers are now among the more confident sectors. Variations by region and size/ownership of companies are small.
A challenging economic outlook despite some improvements
- The Treasury, having already reversed fiscal policy mistakes made during the mini budget, has even been able to relax fiscal policy slightly in the Spring Budget, helped by evidence of the economy improving.
- However, the Monetary Policy Committee (MPC) has still felt obliged to raise interest rates twice during the survey period.
- 2023 is expected to see a modest fall in UK GDP and a marked decline in inflation, but there are likely to be fluctuations from month to month, which is likely to be a restraint on both consumer and business confidence.
The economic outlook improved a little in the first quarter of 2023, helped by a sense that government policy mistakes that had been made in the previous premiership, including unfunded tax cuts, had been firmly addressed by the new Prime Minister and Chancellor of the Exchequer. Indeed, in the Budget on 15 March, the Chancellor announced a £21bn loosening of fiscal policy between 2023-26, thereby slightly relaxing plans he announced upon taking office, and reflecting the slightly better performance of the economy.
Financial markets have also been more stable than in Q4 2022, although interest rates have risen. The MPC lifted its Bank Rate to 4% on 2 February, and raised it further to 4.25% on 23 March, the last day of the current survey period.
The Bank of England has been very clear that if interest rates need to rise further to tackle inflation, then they will, a view that it has held to, despite prominent bank failures in both the US and Europe. There is disagreement over whether further rate rises will in fact occur, although few commentators expect to see rate cuts before the second half of 2023, at the earliest.
Factors underling these judgements include movements in GDP and inflation. January’s GDP rose by 0.4%, and although February’s was flat, that reflected the impact of strikes. The economy probably expanded slightly in the first quarter as a whole, compared with the final three months of 2022. CPI inflation cooled in January, to 10.1%, from 10.5% in December. Energy prices had fallen, and there was some evidence of wage inflation easing. However, February saw a rise in CPI to 10.4%, reflecting increases in food prices, affecting shoppers directly and also pushing up restaurant prices. The year as a whole is likely to see a small fall in UK GDP and a marked easing in inflation, but the paths to those outcomes are unlikely to be completely smooth.
The Business Confidence Index turns positive, but companies remain very cautious
- Business confidence is back into positive territory, but still weak, against a challenging economic background.
- Domestic sales growth has slowed, and a further weakening is expected, with interest-rate sensitive sectors amongst those with the weakest outlooks.
- Export sales growth is not easing, and is not expected to, but is lower than for domestic sales. Brexit and the exchange rate are both factors likely to be impacting export performance.
Business confidence improved in Q1 2023, having been damaged in the previous quarter by the economic policy decisions made during Liz Truss’s brief premiership and the resulting market turmoil. Indeed, the Business Confidence Index moved back into positive territory this quarter, for the first time in a year. However, at +2.5, confidence is still quite weak. Week-by-week numbers do not suggest a strong upward trend within the quarter either, with companies seemingly taking a cautious view of economic and business prospects, against a background of considerable uncertainty.
Domestic sales are at a higher level than in the same quarter a year ago. But at 5.3%, the increase over the period is less than has been seen in recent quarters, and less than in the year to Q1 2022. A further slowdown is expected over the next 12 months. Companies in the Property and Retail sectors have seen the least growth over the year, at 3.4% and 2.8%, respectively. They also expect a noticeably weak year ahead, as do Construction companies. Interest rates are a major factor for all of these sectors, while high inflation has been a real source of difficulty for Retailers, in particular, and for other businesses selling directly to consumers.
Exports have risen by 4.1% over the last year. That is a little less than domestic sales, perhaps partly affected by Brexit. But unlike with domestic sales, the rate of growth of exports has been fairly stable across recent quarters, and businesses are not expecting it to slow. It is possible that a weaker exchange rate has helped to prevent what might otherwise have been a declining trend.
Labour market challenges remain elevated but have eased. Financial challenges are acute in the Construction and Property sectors
- Customer demand remains one of the greatest challenges businesses are facing. Labour market challenges are also very prominent, but have fallen back somewhat, which is probably partly a reflection on the economy slowing down.
- Among labour market challenges, Transport and Manufacturing companies are particularly affected by non-management skill shortages and by staff turnover, while Construction companies face widespread difficulties with the former, and Retailers are especially troubled by the latter.
- Some sectors are particularly affected by financial challenges. The Construction sector faces big problems with bank charges (taken to include interest rates), while access to capital is a major challenge in the Property sector.
Rising numbers of businesses cite customer demand and regulatory requirements as growing challenges they face, reflecting the current uncertain economic background, including pressure from inflation and rising interest rates.
Labour market problems, although still very troubling, are becoming a little less widespread. The trend is apparent with respect to the availability of both management and non-management skills, and with staff turnover. In Q1 2023, 19% of companies cited management skills as a growing issue, while the rate was 29% for non-management skills. And for staff turnover, 29% of companies are being increasingly challenged in this area. And although transport difficulties remain widespread, they are at least not growing, despite some disruption caused by industrial disputes. The slowdown in the overall economy is probably playing a role in easing all of these challenges, alongside particular difficulties with, for example, supply chains, gradually becoming resolved.
Some of these overall patterns vary by sector. Transport and Manufacturing have the most widespread non-management skill shortages, followed by Construction. Transport and Manufacturing also have more difficulties with staff turnover, alongside the Retail & Wholesale sector. A factor that has continued to impact the labour market is the availability of migrant labour, with flows affected in different directions by Brexit, Hong Kong residents moving to the UK, and Ukrainian migrants. Also important has been the decision of some workers, typically people aged over 50, those who are low-paid, and those with long-term health concerns, to no longer seek work.
Other variations include more widespread difficulties with bank charges (taken to include interest rates) in the Construction sector, and with access to capital in the Property sector. That helps to explain why these two are the least confident sectors, overall.
Input price inflation looks to have reached a peak, with businesses’ outlook softening
- Input prices are rising at a record rate since the survey began in 2004. However, businesses expect an easing of input cost pressures in the year ahead.
- Underpinned by the sharp rises in costs, selling prices are also being increased at a record pace. Although the pace of selling price rises remains below input price inflation.
- All sectors anticipate a slowing of input price inflation in the year ahead, particularly within Manufacturing & Engineering and Construction. Businesses in Energy, Water & Mining, and Property plan the slowest rises in selling prices.
Input price inflation has once again reached a record rate, standing at 6.1%, year-on-year, in Q1 2023. This marks the fourth successive quarter where input prices have increased at a record pace. Businesses continue to contend with a number of supply-side problems, with elevated energy costs and ongoing supply-chain disruptions lifting costs for companies. Barriers to trade because of Brexit may also be adding to the cost pressures that companies are facing. However, it is possible that input price inflation has now reached a peak, with expectations of a softer increase of 4.1% over the next year. Predictions that energy prices will ease back to more familiar pre-Ukraine war levels over the coming 12 months may help to explain this outlook.
All sectors expect a slower rise in input prices in the year to Q1 2023. Businesses in Energy, Water & Mining, and Manufacturing & Engineering forecast the sharpest slowdowns in input price inflation. Construction companies also anticipate a markedly slower rise in input prices in the year to Q1 2024, after being particularly vulnerable to supply-side disruptions over the course of 2022.
The steep rises in input costs helps to explain why selling prices are also up by a record rate. Indeed, businesses are lifting selling prices charged to customers by 3.9%, surpassing the previous high of 3.8% reported in the last survey period. That said, much like the outlook for input prices, selling prices are expected to increase at a more modest rate (2.8%) in the next year. Selling prices are being increased most sharply in Energy, Water & Mining, and Transport & Storage. The former of these, however, plans the slowest rise over the year ahead, closely followed by Property.
Strong salary rises expected to continue, but employment growth set to slow
- Annual salaries are rising at a historically high rate, although there are signs that the pace of growth is stabilising. Reinforcing that, companies plan a very similar increase in the year ahead.
- Businesses are expanding their staff levels, but the pace of employment growth continues to slow from its peak in mid-2022. And more modest growth is planned.
- The softer outlook for employment growth helps to explain why staff turnover and the availability of non-management skills, although still prominent, are both now much less widespread issues for businesses.
As well as high input price inflation, labour costs continue to rise sharply for businesses. Indeed, in the 12 months to Q1 2023, average total salaries are up by 4.0%, the joint fastest rate of increase since the survey began in 2004. However, the fact that salaries also rose by 4.0% in the previous survey suggests that growth has stabilised, albeit at an historically very high rate. Expectations are for much of the same in the year to Q1 2024, with companies planning a similar 3.7% rise in average total salaries.
In terms of employment, growth remains in positive territory. In the year to Q1 2023, businesses increased their staff levels by 2.4%, a rate slightly above the survey’s historical average. However, the pace of employment growth has been easing since mid-2022 and is expected to soften further in the next 12 months. Companies intend to increase their headcounts by 2.0%, marking a return to pre-pandemic norms.
The more modest outlook for employment helps to explain why challenges relating to the labour market are becoming less widespread for businesses. Q1 2023 marks the first quarter since Q1 2021 where neither staff turnover nor the availability of non-management skills are the most prominent growing challenges for companies.
Salary growth has been strongest in the Energy, Water & Mining, and Transport & Storage sectors. The latter of these has the most widespread problems with the availability of non-management skills and staff turnover. The former also has the strongest plans for salary rises in the year ahead. The fact that businesses in Energy, Water & Mining are lifting employee levels at the fastest rate across sectors, possibly as a result of strong domestic sales growth, is likely to be putting further upwards pressure on salary growth.
Investment rates set to weaken in the year ahead
- Profits growth remains positive but is slowing, as businesses contend with higher costs and softer domestic demand. A slightly slower rise is expected in the year ahead.
- Capital investment growth is being moderated, and the same can also be said for R&D budgets. A concerning development given their importance for future productivity advancements.
- One sector bucking this trend is Energy, Water & Mining. Businesses here are planning particularly sharp increases in both capital spending and R&D budgets. Ongoing structural changes within the sector partly underpin this.
Profits growth remains positive but has been exhibiting a downwards trend since mid-2021, underpinned by elevated input and labour costs. An increase in the year to Q1 2023 of 4.3% marks a gradual return to pre-pandemic norms. A slightly slower rise of 4.0% is expected in the 12 months to Q1 2024.
In some sectors, particularly Construction, elevated stock levels are likely to be weighing on the profitability of businesses. Although stock levels are now just below the peak of Q3 2022, the proportion of businesses with above normal levels of raw materials and components is still double the historical average for UK companies. This is partly a reflection of the weaker demand environment, along with businesses looking to safeguard themselves from any major surges in commodity prices.
Partly as a result of slowing profits, and softening of domestic sales growth, capital investment is rising at a slower rate. Spending on capital is up by 2.4%, year-on-year, in Q1 2023, a rate that compares unfavourably to the 3.4% rise of a year ago. Further still, businesses plan a slower 1.8% increase in capital investment over the next year. Excluding the sharp declines seen during the pandemic, this would be among the slowest rises in the last decade. This outlook for capital spending is concerning, particularly given the importance of this to future productivity rises and, thus, competitiveness in global markets. That has become more crucial for businesses as they deal with an elevated cost environment and challenges in the post-Brexit trading environment.
In terms of R&D budgets, growth rates returned to the pre-pandemic average of 2.1% in early 2022, and since then have remained rigidly around this rate. Expectations are for a slower outturn of 1.5% in the 12 months ahead. However, it is encouraging that businesses have consistently underestimated the rate of actual R&D budget growth by, on average, 0.3 percentage points since the survey began in 2004.
Across sectors, businesses in Energy, Water & Mining have by far the strongest plans for capital investment and R&D budget growth. The outlook for capital spending is particularly striking, with companies planning the sharpest rise since early 2008. This is likely to have been supported by the sector reporting the fastest increase in profits, year-on-year, in Q1 2023. However, it could also reflect the ongoing structural changes occurring within the sector, with the need for energy companies to decarbonise and adopt greener technologies probably driving higher investment spending.
Confidence by sector
Business sentiment remains very weak in Construction and Property
- The Business Confidence Index is in positive territory across most sectors. Only Construction and Property have negative readings in Q1 2023. Manufacturing & Engineering and Energy, Water & Mining are more confident sectors.
- Domestic sales are rising slowest in the Retail & Wholesale and Property sectors, with the latter also having the weakest growth outlook for the next 12 months. IT & Communications have the most bullish expectations for domestic sales.
- The Property sector continues to contend with widespread problems relating to access to capital. The tax burden has surged as a challenge in the Energy, Water & Mining sector, which likely reflects recent policy announcements.
The Business Confidence Index is now positive across the majority of sectors. The exceptions to this are Construction and Property, with both still some way into negative territory, at -18.7 and -9.7. The indices for Transport & Storage and Retail & Wholesale are also among the lowest across all sectors, although both are now marginally positive. At the other end of the spectrum, businesses in Manufacturing & Engineering and in Energy, Water & Mining are, on balance, more confident, with the indexes rising to +12.5 and 11.5, respectively.
Annual domestic sales growth was weakest in the Retail & Wholesale and Property sectors in Q1 2023. Markedly tighter financial conditions for businesses and consumers alike are undoubtedly weighing heavily on sales here, as well as the erosion of real incomes due to inflation. In the year ahead, domestic sales are expected to rise at the slowest rate once again in Property. Construction, Transport & Storage, and Retail & Wholesale also have very modest outlooks. IT & Communications, closely followed by Manufacturing & Engineering, and Energy, Water & Mining, anticipate the sharpest rises in domestic sales in the upcoming 12 months. In terms of exports, IT & Communications forecast the fastest increase over the next year. Prospects are weakest in Transport & Storage, with exports expected to barely change from current levels.
The weak Business Confidence Index reading for Property is probably also linked to the widespread challenges companies are facing with access to capital. Indeed, the proportion of Property businesses citing this as a growing challenge is more than double the national rate, and markedly higher than all other sectors. Increasing caution from lenders and investors due to the sharp rise in interest rates probably underpins this.
Weak business sentiment in Construction may be linked to the sector having the most widespread challenges with customer demand and bank charges. Meanwhile, marketplace competition is most prevalent in IT & Communications, and Banking, Finance & Insurance. Possibly because of this, these two sectors, along with Property, are increasing selling prices at the slowest rates.
The percentage of companies being increasingly challenged by the tax burden has surged dramatically in the Energy, Water & Mining sector. Since the survey began in 2004, this issue has never been more widespread in any sector than it currently is in Energy, Water & Mining. These concerns are likely to stem from the introduction of the Energy Profits Levy in Spring 2022, and the subsequent increase in this levy from January 2023 onwards. Businesses are also likely to be sensitive to recent changes in the duration of the “windfall tax”, with the levy now set to run until March 2028 rather than the initial end date of December 2025.
Confidence by region and nation
Most but not all regions report confidence in modestly positive territory
- The latest Business Confidence Index shows that businesses in London, Scotland and the North West are least confident about economic prospects. Companies in Yorkshire & Humberside, East of England, and the North East are the most upbeat.
- London businesses have particularly subdued outlooks for increases in both domestic sales and exports. Domestic sales growth expectations are strongest in the East Midlands and Yorkshire & Humber. Exports are forecast to rise fastest in the North East and East of England.
- Access to capital and transport problems are very prominent among London businesses. The tax burden is a very widespread issue among Scottish companies.
The Business Confidence Index has strengthened across most UK nations and regions. Businesses in Yorkshire & Humberside (+13.5), the North East (+8.5), and the East of England (+6.5) are most confident. Especially in the case of the first, this may reflect manufacturing sector confidence. However, sentiment is weakest among companies in London (-0.6), Scotland (-0.2), and the North West (+0.8).
Businesses in the North West and Scotland have the weakest expectations for domestic sales in the year ahead. The growth outlook in London is also below the UK-wide average, possibly affected by concerns over property prices, and higher interest rates impacting on the future growth of financial services, both domestic and international.
In terms of exports growth, businesses in London also have the most modest outlook across all UK nations and regions. Underpinning this, two sectors with a major presence in the capital – Property and Banking, Finance & Insurance – have particularly weak export growth expectations. Along with the East Midlands, businesses in Yorkshire & Humberside anticipate the strongest rise in domestic sales growth in the year ahead. For exports, companies in the East of England and North East forecast the sharpest gains.
Access to capital is a more widespread challenge in London than in any other region, with the exception of the South West. This may partly reflect the importance of the Property sector to the capital, and also perhaps some concern within the banking sector, brought on by a combination of higher interest rates and bank failures in the US and mainland Europe.
Transport problems have also been trending upwards for London businesses, in contrast to the national picture. Recent rail and London Underground strikes may help to explain this. Moreover, Welsh businesses are being especially challenged by late payments, with the proportion of companies citing this now at its highest rate since Q3 2013. The tax burden is most prominent in Scotland, possibly reflecting the importance of the Energy, Water & Mining sector to Scotland’s economy.
Confidence by business size
Companies listed outside of the UK are most confident, closely followed by UK-listed businesses
- The Business Confidence Index is highest for businesses listed outside of the UK. Listed companies are, on balance, more confident than private companies, but there is little variation in the index between large private businesses and small and medium enterprises (SMEs).
- Non-exporting businesses are less confident than exporting companies. Exporters may be drawing some confidence from the weakening of sterling over recent months.
- Access to capital is now much less of a widespread challenge for UK listed companies, while large private companies are most challenged by bank charges.
The Business Confidence Index has improved across all company types when compared to the previous quarter. The Business Confidence Index is highest for businesses listed outside of the UK, while UK-listed companies are slightly more optimistic than UK private companies. Among UK private companies, there is little variation between large businesses and SMEs.
The Business Confidence Index is also lower for non-exporting businesses than for exporting ones. That may reflect differences in expectations for domestic and export sales, while it is also possible that exporters are deriving some confidence from the depreciation of sterling relative to other major currencies, something that makes their goods and services more competitive in global markets.
The variation in sales growth across different company types is small. This also applies to costs and investment rates. That said, there are some differences in the challenges businesses face, which helps to explain the differences in overall sentiment. Notably, large private companies continue to have the highest proportion (18%) of businesses facing growing concerns over bank charges (which includes interest rates). This is not a widespread issue for quoted companies, whether listed inside or outside the UK.
Access to capital has become a much less prominent growing challenge for UK-listed companies in Q1 2023, after a period of considerable nervousness in UK equity and bond markets. The issue is now most widespread for SMEs and large private companies.