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Economic Insight

UK Business Confidence Monitor: Manufacturing & Engineering

Q4 2022: Business Confidence Index declines into negative territory

The latest Business Confidence Monitor (BCM) shows business confidence falling further across the UK as difficult economic conditions combine with political turmoil. The latter has seriously unsettled financial markets, and although some stability has been restored, recent events are likely to result in higher interest rates, taxes and government borrowing, and lower government spending, than previously expected. This has adversely affected business sentiment.

The survey results are based on telephone interviews among ICAEW Chartered Accountants that took place between 25 July and 14 October 2022.

  • The Business Confidence Index for the sector continues its downward trajectory and has entered negative territory for the first time since the peak of the pandemic in late 2020.
  • Growth in both exports and domestic sales is expected to soften over the next year. Supply-side problems continue but the weakening of economic conditions in important international markets is another key factor.
  • Challenges relating to the availability of non-management skills are more widespread than in any other sector. The movement of people out of the labour market during the pandemic may help to explain this. Brexit may also be part of the story here.
  • Average salaries are rising at the fastest pace in the survey’s history, and companies plan another record increase over the next 12 months. That is despite employment growth being weak, partly reflecting productivity gains and the ongoing spread of automation.
  • Annual input price inflation remains at the record high from last quarter. Consequently, selling prices are up by a record pace, and companies plan the strongest selling price rise of all sectors in the coming 12 months.
  • Despite these challenges, investment has been rising. However, plans for the next 12 months are more subdued, with capital investment and Research & Development budgets set to grow at markedly slower rates.

Business confidence in the Manufacturing & Engineering sector

The Manufacturing & Engineering sector has experienced a challenging 12 months. The sector continues to contend with a range of supply-side issues, with staff shortages, major disruptions to raw material supplies, and transportation issues all hindering activity. Some sub-sectors of manufacturing, such as chemicals, have also been particularly vulnerable to the global surge in oil and gas prices due to their energy-intensive production processes. These supply-side problems are occurring against a backdrop of weakening global economic conditions, something that is likely to be weighing heavily on exporters within the sector.

As well as this, Brexit remains an issue within Manufacturing & Engineering, with the new UK-EU trading relationship not only creating short-term frictions but also posing longer term challenges for the competitiveness of UK businesses in European markets.

Partly for these reasons, the Business Confidence Index has fallen into negative territory. In Q4 2022, the index stands at -19.9, comparing unfavourably with the UK national figure of -16.9. This is the first time that the confidence index has fallen below zero since Q4 2020, during the coronavirus pandemic.

Domestic sales and exports growth, and supply-side problems

Domestic sales growth peaked in Q2 2022 and has continued to soften since then. In the year to Q4 2022, domestic sales have risen by 4.6%, a rate that trails the UK average by nearly one percentage point. And companies anticipate much of the same in the year ahead, with a projected growth of 4.8%.

More encouraging is that export growth outpaced all other sectors over the 12 months to Q4 2022, and the annual increase of 5.2% was the fastest in the sector since mid-2018. It is possible that the weakening of sterling over recent months may be boosting export sales growth, as UK goods become more competitive in global markets. However, the outlook for the year ahead is more modest. Businesses expect a 4.0% rise in exports, which is in line with the UK average. 

Modest domestic sales performance and expectations of a slowdown in exports growth are partly the result of persistent supply-chain problems within the sector. These have been amplified by a weakening of activity in the Chinese economy over recent months, as well as by the energy supply problems caused by the Ukraine-Russia war, and its impact on global economic growth. Brexit also remains a problem for many businesses in Manufacturing & Engineering. While the UK-EU Trade and Cooperation Agreement means that trade in goods is tariff free, businesses are having to contend with additional non-tariff costs as they encounter new regulatory barriers. These are likely to be damaging the competitiveness of UK exports in European markets, and that may mean that over the longer term UK companies are squeezed out of pan-European supply chains and markets. Reflecting these challenges, the proportion of businesses citing their ability to expand into new areas as a growing source of difficulty (16%) has picked up, with the issue more widespread only in Construction.

Transport problems also continue to be very elevated, when compared with historical norms in the sector. In Q4 2022 53% of businesses face growing challenges in this area, by far the highest rate across all sectors and nearly double the national percentage. Shortages of drivers have been a major part of this, while port delays due to Brexit may also be impacting the transport operations of businesses.

Labour market and skills

Continuing a trend that has been prevalent for the past two years, annual employment growth in Manufacturing & Engineering remains well below the UK average. An increase in employee numbers of just 2.0%, year-on-year, in Q4 2022 is the weakest across all sectors, with the exception of Property. Companies also plan a similar 1.9% rise over the next year.

It is likely that the pace of employment growth is being hampered by widespread recruitment difficulties. The proportion of businesses citing the availability of non-management skills as a growing issue now stands at 56%, the highest rate of incidence in the sector since the survey began in 2004. This is a more widespread problem in Manufacturing & Engineering than in any other sector. And almost a third (32%) of businesses face increasing problems with the availability of management skills, compared with 25% at the UK level.

Even before the pandemic the UK was experiencing a growing problem with mature workers leaving the labour market, often for health reasons. So, although the ongoing adoption of automation within the sector may be slowing down the growth in demand for labour, the supply of labour is even more constrained. The net result is that average total salaries are increasing at the sharpest rate (3.7%) in the survey’s history, as labour demand outpaces labour supply. An even faster 3.9% rise is expected over the year to Q4 2023.

Input and selling prices, and profits growth

Input cost pressures also continue to intensify for businesses in Manufacturing & Engineering. Reflecting supply-side problems, and the surge in energy costs, annual input price inflation is running at 6.6% in Q4 2022. Along with the previous quarter, this is the fastest rate of increase since the survey began. And these input cost pressures show no sign of letting up. Companies anticipate a further 5.9% increase in the year ahead.

In response, selling prices are being increased sharply, with a year-on-year rise of 5.0% in Q4 2022, the second fastest across all sectors, behind only Construction. And as input price inflation remains stubbornly high, a further rise of 4.5% is projected by Q4 2023. This is the strongest selling price outlook for all sectors.

Despite higher sales and selling prices, profits growth appears to be softening within the sector. Profits are up by only 3.0% in the year to Q4 2022, markedly weaker than in recent quarters. Businesses project a faster increase of 4.5% over the coming year.

Investment

Businesses have increased both capital investment and Research & Development (R&D) budgets. The former is 2.9% higher in Q4 2022 than its level from the year before, outpacing the UK average by one percentage point. R&D budgets are rising at the slightly slower pace of 2.1%, although this is still in line with the outturn for the UK as a whole.

However, the weakening of overall business sentiment, and the increasingly uncertain macroeconomic environment, are reflected in plans for investment over the next year. Spending on capital assets is expected to increase by only 1.9%, while R&D growth is set to be moderated to 1.7%. This projected slowdown in investment growth is a concerning development given that manufacturers are especially reliant on both capital and R&D investment to boost productivity, which ultimately helps to make goods more competitive in both domestic and global markets, something that has become increasingly vital post-Brexit.