Manufacturing steers UK output back into growth

Peter Hemington, head of corporate finance at BDO, looks at the latest data on UK business trends. This month, the manufacturing sector is in the limelight. Its continuing recovery drives UK business output back into growth territory

The latest figures from our monthly economic tracker, Business Trends, show a mixed bag for the UK economy. Manufacturers are winning the race for growth but the services sector continues to lag behind.

The Output Index, which indicates how businesses expect their order books to develop during the next three months, has risen to 95.1 (from 94.9 last month), returning above the point of contraction (95.0). This small increase indicates that output is rising once again, albeit at a very slow speed.

Manufacturing drives growth

The data reveals that the return to output growth has been driven solely by the improving performance of the manufacturing sector. The service sector continues to struggle as output contracts.

BDO’s Manufacturing Output Index increased to 98.6 in July from 97.6 in June, and is rising closer to the long-term growth trend at 100. The recovery of the UK’s manufacturing sector is encouraging for the health of the UK economy.

However, as the sector only accounts for a tenth of all UK economic output, its resurgence has a marginal effect on the overall growth of the economy, reflected by the 0.2 rise in the overall Output Index.

Slowdown in services

BDO’s Services Output Index remained at 94.4 for the second month running, 0.6 below the point of contraction of 95.0. According to ONS figures, the services sector grew 0.5% in Q2 of 2017, but the Services Output Index indicates that order books in the sector are set to shrink in the coming three months, which would leave the growth of the UK economy stuttering towards the end of 2017.

Optimism Index

The Optimism Index in this month’s Business Trends suggests a more positive outlook for early 2018. Indicating how firms expect their order books to develop in the coming six months, the index increased to 103.0 in July, from 102.9 in June.

Echoing the Output Index, the manufacturing sector is responsible for the increase. The results show that UK manufacturers are expecting a flurry of business activity, with its sector Optimism Index climbing to 121.4, well above the long-term trend. However, the services sector outlook for 2018 is less optimistic, with the index falling 0.1 to 99.5 in July, below the long-term trend but still in growth territory.

The overall outlook from UK services has been on a downward trend since 2015, but this has been more distinct since the EU referendum.

Hold firm on interest rates

Amidst slowing growth in the economy as a whole, UK manufacturing is a definite bright spot at the moment. However, our sense is that the recovery is weakening month on month.

Given the continuing ability of the UK to create jobs at a surprisingly fast rate and the relatively high levels of inflation, we can understand the calls for a hike in interest rates. But considering the economy’s direction of travel, we think that tightening monetary policy at this stage would be a mistake.

Further, we believe there is a role for a somewhat more expansionary fiscal policy when Brexit uncertainty starts to bite further as we go into 2018. The Chancellor cannot increase current spending without increasing taxes.  But the markets would be happy to see him borrow more for investment in our productivity and growth potential.

Peter Hemington is Partner and Head of Corporate Finance at BDO