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UK Manufacturing – When will the good times return?

Rhys HerbertRhys Herbert, Senior Macroeconomist at Lloyds Bank Commercial Banking asks when will the good times return for UK manufacturing?

UK manufacturing has had has had a torrid time of it of late and its performance since the financial crisis has generally been tepid at best. Output declined last year and has fallen in three of the last four years. As a result, activity is still about 6% below its pre-recession level.

This is in line with a generally gloomy global picture, with manufacturing activity close to stagnation across a broad range of developed economies. With the pace of manufacturing activity also slowing in China, it would seem that at least some of the reasons for UK manufacturing difficulties are global.

At the heart of these difficulties has been a slowdown in world trade. Latest estimates show that world trade volumes rose by an annual rate of less than 1% in May. That reflects not only weak trade within the developed world, but also more sluggish trade flows to and from emerging markets.

As a much higher proportion of manufactured output, than other parts of the economy including services, are bought and sold overseas, this slowdown has had a marked effect on the sector. Particularly important has been weaker capital spending, due in part to lower oil prices, which have caused oil companies and related producers to cut back on investment.

Lower oil prices should have been a boost to other parts of manufacturing. To date, however, other concerns about the global economy, not least the outlook for China, have stopped them from taking full advantage of the cost reduction. The negative impact on competitiveness of a strong pound, particularly versus the euro has been an additional hurdle.

Still it has not been all bad news. Indeed in the run-up to the referendum it seems that manufacturing had a new lease of life. According to the UK Office for National Statistics, manufacturing output grew by almost 2% in the three months to the end of June, its fastest quarterly growth rate for more than a quarter of a century.

That almost certainly overestimates the underlying pace of growth and it should be noted that most of the improvement occurred in April. Nonetheless, manufacturing seems to have been in better shape in the run-up to the referendum than was generally believed.

The international focus of UK manufacturing could now become a significant plus. Generally speaking the world economy is holding up reasonably well. China for example, while experiencing a slowdown, remains one of the fastest growing parts of the world economy and is still expected to grow by more than 6% both this year and next.

The US economy is also growing at a decent pace and is currently sucking in an awful lot of imports. These two combined account for over 35% of the world economy more than twice the share of the European Union. Given their size and strength they clearly offer substantial opportunities for UK exporters, particularly given the new uncertainties facing the UK’s trade relationship with the rest of Europe.

Admittedly the outlook in the UK’s single biggest export market, the Eurozone, continues to look more uncertain. The latest concern, at least for some, is the health of the European banking sector and particularly some Italian banks.

It is difficult to gauge whether those concerns are justified but certainly downside risks for the European economy continue to exist. Nevertheless, with most economic forecasters still expecting the Eurozone economy to grow this year at its fastest rate for six years, it may be less of a drag on UK manufacturing exporters than is currently expected.

That is particularly the case given, sterling’s depreciation since the autumn of last year. That has provided a boost to competiveness that in the past has led to an acceleration in export growth.

The pound has fallen further since the referendum reaching a 31-year low against the US dollar. Against the euro it is admittedly only back to levels last seen in 2013 but even that represents roughly a 17% depreciation since November of last year.

But what about the domestic economy? Certainly a number of surveys suggest that both business and consumer confidence has fallen sharply in recent weeks in the wake of the referendum. It remains unclear, however, whether this is primarily a knee-jerk reaction to the referendum or something that will be sustained longer term.

Also as of yet we have not seen any hard data of what has happened to economic activity over the last month. So we have little idea of the impact of this decline in confidence and whether it is actually causing people to spend less or companies to produce less.

In the meantime, UK manufacturing, which exports more than 50% of its output may experience at least a temporary boost from exchange rate depreciation. That could mean that even given current uncertainties much of UK manufacturing could end the year in better shape than they started it.

Undoubtedly there are risks out there that it would be foolish to play down. There are difficult and complicated questions to be ironed out over the next few years about out trade relationships with the rest of the EU and wider afield. So the outlook remains uncertain.

That doesn’t mean, however, that it is all doom and gloom. The fall in the exchange rate should provide at least a temporary cushion for manufacturing, while the potential opening up of new markets provide significant opportunities over the longer term. So in all there are still opportunities out there for UK manufacturing to thrive.