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UK Business Confidence Monitor: Manufacturing & Engineering

Q4 2021: Sales expected to rebound but supply-side issues continue to bite.

  • After seeing a rebound in activity during the spring, the pace of recovery in Manufacturing & Engineering has begun to wane in recent months, reflecting persistent supply chain problems. The Business Confidence Index has fallen from the previous quarter, although it remains high. 
  • Year-on-year growth for domestic sales is now back in positive territory and is expected to see stronger gains over the 12 months ahead. The outlook for exports is more muted, possibly relating to difficulties in adjusting to the new UK-EU trading arrangement. 
  • Businesses plan to significantly increase employee levels over the next year. However, this may be obstructed by the availability of non-management skills becoming a more widespread issue in the sector than at any point since the survey began in 2004. 
  • As well as labour supply challenges, transport problems are more prominent in Manufacturing & Engineering than any other sector. Freight capacity constraints, HGV driver shortages and Brexit-induced port problems are all probable factors behind this. 
  • Businesses in Manufacturing & Engineering are facing higher input cost pressures than elsewhere in the UK economy, as they contend with supply-side disruptions and raw material shortages. In turn, selling prices are rising sharply. 
  • On a positive note, both capital investment and R&D budgets are expected to be higher in the coming 12 months, possibly in response to rising demand, mounting capacity limits and tougher international competition post-Brexit.  

Following sharp declines during the initial period of lockdown in 2020, Manufacturing & Engineering output growth markedly improved in the second half of the year. However, the reintroduction of a nationwide lockdown during the early stages of 2021 and volatility stemming from Brexit hampered the sector’s recovery. The gradual withdrawal of restrictive measures since then contributed to a strong rebound in demand for manufactured goods, both domestically and internationally. That said, in recent months the sector has begun to lose momentum as new challenges emerge in the recovery from the pandemic. Although domestic and global demand remains very strong, headwinds from material and component shortages, supply chain disruptions and transport bottlenecks have all prevented output from keeping pace with demand. And these supply-side problems are combining with higher energy and commodity prices to drive up input costs for businesses.  

Against that backdrop, the sector’s Business Confidence Index stands at +29.1 in Q4 2021. That is comfortably above the historical average for the sector, but lower than the record high seen in the previous quarter.

Domestic sales and exports growth

Businesses within Manufacturing & Engineering were affected by the recurring periods of lockdown, with the pandemic depressing demand, disrupting supply chains and leading to pauses in on-site activity. However, activity in the sector has rebounded since the early months of 2021. The net effect is that domestic sales are 2.4% higher, year-on-year, in Q4 2021. Export growth has been more muted, rising by just 0.1% over the same period, reflecting weakness in some overseas markets. Exporters also face an additional obstacle in the form of new UK-EU trade barriers. Although the Brexit free trade agreement keeps UK-EU trade tariff- and quota-free for qualifying goods, the new relationship has introduced new customs and regulatory barriers that are weighing on the international competitiveness of manufactured exports.

The latest production data from the Office for National Statistics (ONS) underline the recovery path of the sector. In September 2021 total manufacturing output was 5.8% higher than a year earlier. The majority of sub-sectors were also above their levels from a year ago.

Companies also expect sales performance to significantly improve in the year ahead which, in turn, underpins the continued high level of confidence in the sector. Domestic sales are expected to increase by 5.5% in the 12 months to Q4 2021. This would be a record rise for the sector. And the pace of export growth is forecast to pick up to 3.8% over the next year. However, both projections trail the respective national outlooks, with persistent supply-side issues and Brexit challenges possible factors impacting the outlook.  

Labour market and skills

Companies in Manufacturing & Engineering cut employment at a faster rate than nationally during the pandemic. And despite an improving demand environment since then, staff levels are still down by 0.2% year-on-year in Q4 2021. The situation looks likely to be markedly different for the 12 months ahead. Businesses plan to expand their headcounts by 2.6%, which would be a near record rate of increase for the sector. However, businesses are encountering a number of labour market challenges with respect to skills and recruitment. This is likely to reflect many businesses all trying to recruit workers at the same time to meet surges in demand. The proportion of businesses for whom the availability of non-management skills is a growing challenge stands at 45%. This is the highest rate across all sectors and the highest seen in Manufacturing & Engineering since the survey began in 2004. Staff turnover is also now a much more prominent growing challenge than at any other time since the start of the survey.

An expected rise in employment, coupled with growing concerns about skills, is set to result in a pick-up in average total salaries. After rising by 1.4% year-on-year in Q4 2021, companies anticipate a 2.6% increase in salaries over the next 12 months.

Business challenges

Businesses in Manufacturing & Engineering are also facing a range of other challenges. Transport problems are a growing source of difficulty for 71% of companies. This is by far the highest rate of incidence across sectors and around four times higher than the historical average for the sector. Freight capacity constraints, due to high demand and ongoing COVID-19 restrictions on air transport, are likely to be a reason for this. Shortages in HGV drivers may also be a part of the story here, while Brexit-induced logistical problems at ports may also have impacted the operations of many manufacturers and slowed down delivery rates.

Regulatory requirements are also among the most prominent growing issues, with 40% of companies challenged by these in Q4 2021. New UK-EU regulatory procedures for importing and exporting manufactured goods may be causing some distress for businesses.

On a more positive note, customer demand challenges have eased considerably over recent quarters, no doubt reflecting the sharp upturn in economic activity: 39% of businesses cite this in the year to Q4 2021, compared to a pandemic peak of 59% in Q4 2020.

Input and selling prices, and profits growth

Ongoing supply chain disruptions, shortages in raw materials and transport bottlenecks look to have been felt more severely within the Manufacturing & Engineering sector than elsewhere in the economy. In the year to Q4 2021, input prices increased by 4.9%, which is the sharpest rate across all UK sectors and the fastest rise in the sector for over a decade. Input price inflation is expected to ease in the year ahead to 3.3%, probably underpinned by expectations that the existing supply-side issues will dissipate. However, the projection here will still be the joint fastest across the UK, along with Construction. And these cost increases have been passed onto consumers. Selling prices are up by 2.6% year-on-year in Q4 2021, more so than any other sector. Businesses also plan a further 2.6% rise in the 12 months ahead, which again outpaces other parts of the economy. The net effect, coupled with the sales outlook, is that profits are forecast to be 4.7% higher year-on-year in Q4 2022. While this would be a marked improvement on recent growth rates, it trails the national projection of 6.1%.

Investment

Despite the difficulties that businesses in Manufacturing & Engineering are facing, it is encouraging that investment spending is expected to increase. For the 12 months ahead, capital investment plans are strongest in Manufacturing & Engineering when compared to all other sectors, with spending here forecast to rise by 3.8% year-on-year. This may be partly related to growing capacity constraints in the sector, with some companies needing to expand their capital stock as the recovery builds. The proportion of businesses operating below capacity has fallen sharply in recent quarters and now stands at its lowest rate (52%) since the survey began in 2004.

Research & Development (R&D) budgets are also expected to increase at a faster pace (2.8%) in the coming year. Manufacturers have historically been reliant on this area of spending to improve their competitiveness, an issue that has been amplified by the new post-Brexit trading environment and ongoing supply-side challenges.