Q1 2026: Business sentiment finally moves into positive territory, but uncertainty remains.
The latest national Business Confidence Monitor (BCM) shows that business sentiment was on course to move into positive territory in Q1 2026, but the outbreak of the Iran war had a dramatic impact in the final weeks of the survey period, with confidence deteriorating sharply. While businesses reported improved annual domestic sales and exports growth and easing input price inflation compared with Q4 2025, the war introduced significant downside risks to the outlook for the coming year.
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 12 January to 16 March 2026.
- Business confidence in Manufacturing & Engineering moved into positive territory in Q1 2026 at +1.7, but the Iran war is a significant risk to the sector outlook.
- Annual exports and domestic sales growth both strengthened in Q1 2026, showing an improvement on recent quarters, albeit lower than the national averages.
- Labour costs are the main growing challenge for businesses, with the tax burden, customer demand and energy costs also prominent.
- Input price inflation remains high despite a modest slowdown and profits growth improved but the recent rise in energy prices could further affect businesses.
- Employment rose for the first time in Q1 2026 after three quarters of decline but wage inflation also accelerated.
- Companies are relatively upbeat about capital expenditure growth but intend to curb R&D budget growth over the coming year.
Business confidence in the Manufacturing & Engineering sector
Sentiment in the Manufacturing & Engineering sector improved in Q1 2026, following a negative dip in the last quarter. The sector’s Business Confidence Index is now at +1.7, above the national average which remained in negative territory at -1.1, but still below the sector’s historical norm (+4.7).
UK manufacturing remained under strain last year, as tighter financial conditions, soft domestic orders, US tariff frictions and wider geopolitical tensions dampened output. Margins were compressed by higher input costs, especially industrial electricity prices, and sustained wage pressure. But sentiment edged up recently and businesses reported improved domestic sales and exports growth. The Bank of England’s March 2026 Agents’ Summary notes that while manufacturing output is still weak, the pace of contraction has moderated, supported by continuing strength in defence, aerospace and renewables, and a rebound in automotive as supply chains normalise. December’s cut in Bank Rate to 3.75% should, at the margin, encourage capital spending, but so far business have remained cautious amid volatile demand and policy uncertainty. Looking ahead to 2026, heightened tensions in Iran add another risk, particularly for energy‑intensive producers exposed to energy price spikes and logistics disruptions.
Exports and domestic sales growth
Annual exports growth accelerated to 2.3% in Q1 2026, an improvement on recent quarters, though still below the national average of 3.3% and the sector historical norm (2.5%). Looking ahead, Manufacturing & Engineering businesses are upbeat with respondents anticipating exports growth of 4.5% over the year compared to the average outlook of 4.1%. Even so, recent tensions in the Middle East have likely tempered expectations and could weigh on production schedules, logistics and near-term exports performance, keeping risks tilted to the downside.
Domestic demand also strengthened, with sales rising 2.2% in Q1 2026 ‒ up from 0.9% in the previous quarter ‒ pointing to improving order books and a gradual normalisation in operating conditions. While results should be read cautiously given the fluid geopolitical backdrop, companies expect domestic sales growth to rise to 5.1% over the next year, slightly below the national average of 5.4%. Overall, momentum is building from a low base, but external risks and potential supply-chain disruptions remain significant headwinds.
Business challenges
In Q1 2026, 52% of Manufacturing & Engineering businesses reported labour costs as a growing challenge, underscoring how payroll pressures are becoming a central constraint on operations. This is a new survey indicator, so there is no historical series for comparison yet. The broader tax burden is also a significant issue, cited by 47% of respondents, though down from the survey high of 63% reported last quarter.
Customer demand remains weak, with 37% of businesses citing the issue as a growing challenge. A key driver is eroding international competitiveness with the UK facing among the highest industrial electricity prices among International Energy Agency countries, around twice the European average, and recent tensions in the Middle East are adding renewed pressure to energy markets. Reflecting this, 37% of Manufacturing & Engineering firms cite energy costs as a significant challenge, a share that could rise if price volatility persists.
Market expansion is also deteriorating. The Bank of England’s March 2026 Agents’ Summary reports that a rebound in car manufacturing, together with persistent resilience in defence, aerospace and renewables, has contained the pace of contraction, though overall production is still subdued. Rising costs and weak investment intentions are intensifying global competition. BCM data corroborate this, with 36% of businesses reporting competition in the marketplace as a growing challenge.
Labour market concerns remain prevalent among Manufacturing & Engineering businesses. Of the businesses surveyed in the sector, 15% cited the availability of management skills, while 22% reported increased concern over non-management skills. Both issues were more prevalent compared to the UK average (9% and 13% respectively), with the latter concern more widespread than in any other sector.
Labour market
The first quarter of 2026 saw the first headcount increase in Manufacturing & Engineering in almost a year, with annual employment up 1.0%. The sector had been particularly squeezed by last year’s rises in employers’ National Insurance Contributions and rises to the National Living Wage, but the uptick in headcount suggests firms are gradually adapting to the higher cost base. This quarter’s gain outpaced the sector’s historical norm (0.4%) but still trailed several other industries, including Energy, Water & Mining (2.2%). Looking ahead, Manufacturing & Engineering businesses are relatively optimistic, projecting workforce growth of 1.4% over the coming year, slightly above the national average projection of 1.3%.
Wage inflation lifted to 3.1% this quarter and remains well above the sector’s long‑run norm of 2.1%. Companies expect wages to rise by 3.0% over the coming year, the second‑highest projected rate after Business Services (3.1%). In a context of reported skill shortages and difficulties attracting talent to the sector, higher pay growth could help support workforce retention and supply in a tight skills market. But it will equally reinforce the need for productivity improvements to remain competitive.
Input and selling prices, and profits growth
Following an uptick in input costs in Q4 2025, this quarter shows a modest slowdown. However, at 3.4%, input price inflation still exceeds the sector’s 3.1% historical average. For energy-intensive segments such as chemicals and basic metals, electricity remains pivotal, and relatively high UK power prices continue to bite. Meanwhile, the geopolitical backdrop in the Middle East heightens upside risks to energy prices and logistics, threatening renewed volatility.
In line with higher input costs, selling prices have also surged this quarter, with a reported inflation of 2.9%. This was the highest level of cost inflation since Q2 2024 and only lower than the rise in Business Services (3.1%). Companies in the sector plan to ease selling prices growth slightly over the next 12 months, to 2.4%, broadly in line with the national projection (2.3%), but still above the sector’s historical norm of 1.8%.
Despite the challenging economic conditions, Manufacturing & Engineering companies managed to increase their profits in the first quarter of 2025, with growth rising to 2.5%, marginally ahead of the sector’s historical norm (2.4%). Even so, profits growth remains below the national average reported for this quarter (3.1%). Manufacturing & Engineering businesses anticipate strong profits growth over the next 12 months, at 5.2% and in line with the national average. That said, recent geopolitical tensions could temper those expectations.
Investment
Capital expenditure growth in the Manufacturing & Engineering sector rose slightly from the previous quarter to 1.5%, close to the sector’s historical average (1.7%) and businesses plan to raise their capital investment expenditure to 1.8% over the next 12 months, which is close to the national average projection (1.9%).
R&D budgets also increased this quarter to 2.5%, exceeding the historical average of 2.1%. Companies plan to moderate growth in R&D expenditure this year to 1.4%, which is in line with the national average but remains low by historical standards (2.1%).