Confidence within British manufacturers is at its lowest level since the financial crisis following the Brexit vote, despite "encouraging" signs that factories were benefiting from a weaker pound, a survey has found.
Following a slowdown in activity towards the end of 2015, which spilled over into the first half of this year, the latest quarterly CBI Industrial Trends Survey (http://news.cbi.org.uk/news/manufacturing-prospects-muted-after-brexit-cbi/) showed that the sector had a decent recovery over the three months to July. Output rose at its fastest in two years, while domestic orders and employment also improved. Export orders were flat, but improved on the fall seen in the previous quarterly survey.
But despite this improvement in activity, optimism about the business situation over the past quarter fell at the fastest pace since January 2009, in the aftermath of the referendum result. In a poll of more than 500 manufacturers taken in the two weeks immediately after the 23 June referendum, the CBI said member firms were in cautious mood as they sought to work out what the decision meant for access to Europe’s single market. Meanwhile, the outlook for the next three months is set to soften, with expectations for total new orders growth at their lowest since January 2012, output growth set to ease and headcount expected to fall slightly.
Looking ahead to the coming quarter, concerns over economic and political conditions abroad as a constraint on exports orders are at their highest level since 1983. Yet, competitiveness in international markets has improved at the strongest pace in over six years, with a further boost expected next quarter. As a result, export orders are set to rise at an above-average pace over the next quarter.
Investment is also expected to be lower over the coming year compared with the last twelve months, with planned capital expenditure on buildings and plant & machinery easing from the multi-decade highs seen in the previous survey. Nevertheless, both were still broadly in line with average levels.
Rain Newton-Smith, CBI chief economist, said: “Manufacturers picked up the pace over the second quarter, with output growing solidly. We’re also seeing encouraging signs of a boost to export competitiveness from a weaker sterling.
“But it’s clear that a cloud of uncertainty is hovering over industry, post-Brexit. We see this in weak expectations for new orders, a sharp fall in optimism and a scaling back of investment plans.
“So, it’s important now for the new Government to steady the ship with a plan, and a clear timetable, for negotiating the UK’s relationship with the EU. This, along with a renewed focus on industrial strategy, will help give firms the confidence they need to grow and create jobs.
“Manufacturers look forward to working with the new Government to preserve the openness of the UK’s economy to markets, skills and trade.”
Only 5% of the businesses surveyed by the CBI said they were more upbeat about their future prospects than they were three months ago while 52% said they were more pessimistic. The gap of -47% was the biggest since January 2009, a period when global trade and industrial production was declining at its fastest rate since the great depression of the 1930s.
Total order books are expected to be flat over the next quarter, although exporters believe they stand get more business because the fall in the value of the pound will make their goods more cost competitive. On the downside, CBI members believe the higher cost of imports will push up their costs.
The survey found that firms were planning to cut spending on both new buildings and plant and machinery. In the previous industrial trends survey a balance of 6% of firms said they intended to invest more in buildings and a balance of 17% had plans for new plant and machinery. In the latest survey, these balances had fallen to -23% and -5% respectively.
Paul Hollingsworth, UK economist at Capital Economics, said the sharp drop from +23 points to +6 points in the balance of firms expecting output to rise over the coming three months suggested the sector was on course to contract.
He said: “Taken together with last week’s flash manufacturing PMI, the evidence is mounting that the economy has taken a hit from Brexit. But it is still early days and the survey evidence so far could reflect an initial shock factor. We will have to wait a while longer before we get a clearer picture of just how big the immediate impact has been.”
Kaizen’s experience of recruitment of senior level professionals in the engineering and manufacturing industry is that some decisions in the boardroom are being put on hold and this is having a knock-on effect on some recruitment processes being suspended. However, with a continuing 1.82m shortage in skilled workers in the sector, demand continues to outstrip supply and companies are still hiring and there are lots of opportunities.
The Brexit decision raises significant challenges and potential opportunities for all multinational companies that trade with and operate in the United Kingdom. We look at the key questions for the manufacturing industry.
Trade
The EU is currently Britain's biggest trade partner. More than 50% of the UK's exports go to the EU. Four of Britain's six biggest export partners are EU Member States, the other two being the US and China. The EU is also Britain's closest trade partner, and empirically (according to analysis by CityUK) trade declines with distance.
Once the UK leaves the EU, on what terms will it be able to access EU markets? Various alternatives have been proposed, including the Norwegian, Swiss and Turkish model (of which no doubt more will be said in coming months). It is not clear whether any of these models would be as favourable as the current customs union. Britain will be hoping for a bespoke arrangement.
Without the EU behind it, how will Britain fare at the negotiating table when doing trade deals with non-EU countries? The EU currently has 23% of world GDP - the UK only 3.5%. The US has said that it is not interested in a UK-US free trade agreement. That said, EU trade agreements are slow to negotiate and often the product of compromise - potentially Britain, a leader on the global stage, could be able to do better alone.
What would be the effect of a post-Brexit reduction in trade? A reduction in trade has been linked to reductions in productivity and innovation on the basis that, as market size and competition shrink, productivity may do the same (again, CityUK has done the analysis).
Will restrictions on the free movement of people from and to other Member States have a positive or negative impact? This remains to be seen, but in the immediate aftermath of the referendum, immigration is high on the agenda.
Red tape
Manufacturing is highly regulated, and most of this regulation emanates from Brussels. However, it is unlikely that regulation is going to lessen following a Brexit. Some EU-derived requirements reflect the perceived need in the UK in any event. Where those requirements have direct effect in the UK, through Regulations, the UK will need to decide whether to adopt these requirements or allow them to lapse on a Brexit.
If the UK wants to continue to do business with the remaining EU Member States, it will almost certainly need to comply with EU regulations in order to do so - but unfortunately without the ability that it previously had to negotiate, influence or challenge those regulations. Manufacturers may have to comply with UK as well as EU legislation, which may well diverge over time or at minimum be applied inconsistently.
Foreign Direct Investment (FDI)
According to EY (in their Attractiveness Survey), the UK attracted more FDI projects than any other European country in 2014. Many investors regard the UK's access to the EU as an important part of its appeal.
It is possible that FDI will reduce in the period of uncertainty that now follows the outcome of the referendum, with investors understandably more cautious. Will international companies based in the UK (or even some domestic companies) relocate elsewhere in the EU in the event of a Brexit? Some foreign investors - such as Siemens - have already signalled the importance to their business of Britain's EU membership.
That said, Britain still has plenty to offer investors in terms of timezone, language, skills, legal system and culture. Market forces will continue to operate and strong/innovative UK businesses would hope that European customers would still deal with them.
Kaizen Comment
Before the referendum, the Brexit debate was full of questions. Following the outcome, if anything the uncertainties have increased. Will the UK be more prosperous or poorer following a Brexit? How far will GDP fall, if at all? Will the UK become more regulated or less? What will happen to Scotland now that the UK has voted to leave the EU? At this stage no-one knows for sure. But one thing is clear. The impact will be wide ranging and will affect different sectors and particular commercial interests in different ways.
Companies which operate in the United Kingdom will need to quickly re-assess their Brexit contingency planning in order to identify core areas of interest for the exit negotiations and understand how and where to engage to influence those discussions towards their commercial objectives. Many UK companies will now be seeking to support and influence the UK Government in these vitally important negotiations.