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UK Business Confidence Monitor: Manufacturing & Engineering

Q3 2021: A strong rebound in sales underpins improvement in business confidence.

  • After collapsing during the early stages of the pandemic, output in the sector rebounded through much of 2020 and into 2021. However, the recovery has lost momentum in recent months due to supply-side disruptions.
  • Both domestic sales and exports are still slightly below their levels from a year ago. That said, companies expect a sharp upturn in sales performance over the year ahead as pent-up demand is released and supply-chain issues unwind. This explains why the Business Confidence Index has risen to its highest ever level in Q3 2021.
  • After experiencing declines over the last 12 months, companies plan to increase their employee numbers. Partly in consequence, the availability of non-management skills is now becoming a more prominent challenge in the sector. 
  • The proportion of businesses citing transport problems as a more pressing issue is at its highest ever rate in the sector. COVID restrictions and Brexit are probable factors behind this.
  • Input prices are picking up in the sector as manufacturers deal with supply bottlenecks, shortages in raw materials and Brexit-induced trade frictions. Input price inflation is set to be faster than in any other sector in the 12 months ahead.
  • More encouraging is that investment rates are projected to improve. Growth in capital investment is set to outpace the all-sector average, while Research & Development budgets are expected to rise at a faster rate than the past year.

Businesses in Manufacturing & Engineering have endured an extremely challenging past year. Output plunged in the initial stages of the coronavirus pandemic as global containment measures depressed demand, disrupted supply chains and caused many companies to pause onsite activity, except in those sub-sectors such as food manufacturing and the production of protective clothing, where demand held up or even increased, and where it was essential to keep production.

The sector then rebounded strongly in the second half of 2020 as demand gradually returned, and as manufacturers were permitted to continue operating despite recurring periods of lockdown. However, the reimposition of a nationwide lockdown and Brexit distortions halted much of the recovery in the early stages of 2021. Growth resumed in the sector as a result of this, although in recent months the recovery has once again begun to wane. Supply bottlenecks have emerged, and input shortages and freight delivery delays have impeded manufacturers’ ability to meet the strong rebound in domestic and global demand for goods.

Nevertheless, businesses expect that these supply-side issues will gradually unwind and that sales will rise sharply in the year ahead. Reflecting this, the Business Confidence Index for Manufacturing & Engineering has risen to its highest level (+43.7) since the survey began in 2004. 

Domestic sales and exports growth

Many businesses in Manufacturing & Engineering were very vulnerable in the periods of lockdown over the past year. And although demand has picked up in the sector, domestic sales are still 1.2% lower than their level of a year ago. The pandemic has, of course, not just been confined to the UK. Demand in all important international markets also plummeted during the pandemic. Consequently, exports are still 0.7% below their level from the 12 months before. 

However, the improvement in overall confidence stems from the optimistic sales outlook for the year ahead, as pent-up consumer demand is released and production issues fade. Domestic sales are projected to expand by 6.8%, which would comfortably be the fastest rate of growth ever seen in the sector if achieved. Export growth is also expected to markedly improve, albeit at the slightly slower pace of 4.4%. This would be the fastest rise in the sector for three years. Associated with this, the percentage of companies citing customer demand as a growing challenge has eased from a pandemic peak of 59% in Q4 2020 to 39% in Q3 2021. 

The latest data from the Office for National Statistics (ONS) underlines the recovery in the sector while also confirming some marked variations in sub-sector performance over the past year. In the 12 months to June 2021, total manufacturing is 2.5% higher than the previous 12 months. The majority of sub-sectors are now above their levels from a year ago. An important exception is the transport sector (mainly automotive and aerospace), in which output is still some way below a year ago, reflecting not only the severe impact of lockdowns on vehicle demand, but also the disruptive impact of the global shortage in semiconductors on the sector’s recovery.

Employment and skills

Businesses in Manufacturing & Engineering lowered their employee numbers over the last year by 1.5%, a sharper cut than the average across all sectors. Even so, the contraction is much less severe than seen during the global financial crisis. This largely relates to the impact of the government’s Coronavirus Job Retention Scheme in limiting the impact of the pandemic on the labour market. The situation looks very different for the year ahead. As sales rebound, businesses intend to increase their headcounts by 2.7%. If this were to materialise it would be the joint-fastest increase since Q1 2015.

A rise in employment should also stimulate a pick-up in average total salary growth. Companies plan an increase of 2.0% over the next 12 months, after restricting rates over recent quarters. A related reason is growth in concerns about skill. The proportion of businesses for whom the availability of non-management skills is a growing challenge stands at 28% this quarter. This is the joint-highest rate across all sectors. Staff turnover is also more widely cited as a rising concern (29%) in Manufacturing & Engineering than in any other sector in Q3 2021.  

Input prices and profits growth

As well as rising labour costs, input prices are picking up in the sector. Persistent supply-chain disruptions, bottlenecks and rising shipping costs are all likely to be reasons behind this. It is also possible that rises in freight costs post-Brexit could be a factor too. And businesses are forecasting faster input price inflation (3.1%) than in any other sector over the next 12 months. Selling prices saw the sharpest year-on-year increase (1.4%) across all sectors in Q3 2021. Businesses also intend to respond to further rises in costs by lifting their selling prices by 1.9% in the coming year. Overall, the planned increase in selling prices and expected growth in sales should help to lift profits considerably. These are projected to increase by 6.9% in the year to Q3 2021, after suffering declines during the pandemic. 

Business challenges

Although a recovery has begun to form in the sector, there is still a wide range of challenges facing businesses. Manufacturers are particularly sensitive to transport problems: 63% of companies cite this in Q3 2021, by far the highest rate of incidence ever seen in the sector and more than double the national average in Q3 2021 (27%). The sector has been especially vulnerable to the air and road-freight capacity constraints of recent months. Companies have also probably been challenged by port delays due to Brexit barriers. Recently, disruptions due to a shortage of transport workers have been a particularly marked part of the explanation. Challenges in adapting to new on-site COVID measures as well as changes to the EU-UK regulatory process are also possible reasons why regulatory requirements are becoming a more prominent issue. In the latest quarter, 41% of companies report this as a growing issue, which is slightly above the all-sector average. 

Investment

The expected rise in sales as trading disruptions dissipate and pent-up demand is released should also provoke an increase in investment. After being cut over the past year, spending on capital assets is forecast to rise at a faster rate (3.4%) than nationally over the next 12 months. The fact that the planned growth in capital spending does not match the projected outlook for sales may be due to the high proportion of companies still operating below capacity in the sector (54%) when compared to the national figure. This implies that many businesses in Manufacturing & Engineering will not need to immediately expand their capital stock as the recovery gains further traction. 

It is also encouraging that Research & Development (R&D) budgets are expected to increase at a faster pace (1.9%) in the coming year. Manufacturers have historically been reliant on this area of spending to boost their competitiveness, which has become even more important now as businesses contend with Brexit-induced trade frictions and supply-chain difficulties.