The Office for National Statistics (ONS) raised eyebrows amongst analysts on Monday when it reported a drop in its production index of 0.7 per cent, between the months of April and May. Contributing largely to the fall was a plunge in factory output from April, which represented the largest contraction since January 2013 and the first decline in six months according to a spokesperson from the ONS. The output of 10 manufacturing categories out of a total of 13 declined in May compared to the previous month, informed the statistics office. The biggest contributors to the disappointing output figures were basic metals, which decreased 2.3 percent, and pharmaceuticals, which also slid 3.6 percent during that period.
The latest ONS production figures took a lot of economists by surprise. Indeed, the median forecast of 25 economists was for a gain of 0.4 per cent, according to a recent Bloomberg news survey. So, May’s slump in UK manufacturing was a bit of a damp squib for the markets. After all, UK domestic consumption remained buoyant during the first quarter of 2014, spurred on by the Bank of England’s expansionary monetary policy, which facilitated cheap and readily available credit. The upshot of a loose monetary policy was a boom for manufacturers, who reported the biggest rise in domestic sales since the survey started in 1989 in the first quarter of 2014. Contributing to this figure were British consumers who splashed out on new cars, at their fastest rate in nine years. A whopping 1.29 million new vehicles were sold in Britain during the first half of the year, which represented a 10.6 per cent increase in sales from the same period last year, according to the Society of Motor Manufacturers and Traders (SMMT). Ford Fiesta, Vauxhall Corsa and Ford Focus were top on the buyers’ list. “Britain's car industry has smashed records going back to 1959 with the longest-ever period of sales growth of new cars,” said Mike Hawes, SMMT chief executive. Car manufacturing in Britain also increased during the first half of the year as foreign owned companies invested in production lines at their UK factory plants. Apparently, this trend is expected to continue with manufacturing output for cars predicted to return to levels not seen since the 1970s where a record 1.92 million vehicles were built in Britain during 1972, according to SMMT. Last year the total was 1.51m cars, which represented a six-year high.
However, while domestic consumption provided strong tailwind for UK manufacturing, in the first half of 2014, UK exports remain lackluster during the same period.
The lingering recession in many parts of the Euro zone didn’t help boost UK manufacturing sales. UK exports to the EU fell by £11.5 billion in the month of April 2014, which is a decrease of £2.1 billion (15.8 per cent) compared to last month. It is also a decrease of £0.6 billion (4.9 per cent) compared to April 2013. Certainly, bitter austerity is biting hard in the southern countries of Europe and public health cuts were most probably contributing to falls in UK pharmaceuticals exports to the region. Additionally, Britain’s exports outside the EU declined, the trade deficit rose to £8.92 billion in April, 2014 compared to £8.29 billion in March, representing a decline of 1.5 percent in manufacturing exports, according to a recent Bloomberg article.
Furthermore, the strengthening pound against the euro and dollar could also be a contributing factor providing headwinds for UK manufacturers, which was reflected in May’s dismal manufacturing figures. The appreciating pound is making UK manufacturing exports more expensive and thereby less competitive abroad. Furthermore, the Bank of England’s perceived hasty move to tighten monetary policy could also be strengthening the pound even further, providing more anxiety to UK manufacturing. Underscoring this view Samuel Tombs, an economist at Capital Economics in London said, “The data suggest that the stronger pound might be starting to slow the recovery in the manufacturing sector.” However, on an upbeat note he added that, “Despite today’s disappointing figures, we continue to think that the economic recovery will receive decent support from the industrial sector.”
Michael Saunders, UK economist at Citi also played down May’s disappointing output figures. "We do not regard these data as a sign that the economy's rapid expansion is losing momentum," he said and cited a series of positive industry data to back his support. Manufacturing output has increased 2.3 percent from a year earlier and was up 0.6 percent in the three months through May from the previous quarter.
However, while the ONS cautions into reading too much into one set of monthly figures, there are some strong headwinds for UK manufacturing in the months that lie ahead. External factors such as a slowing global economy could put a further dampener on UK manufacturing exports. Moreover, the benign climate of low interest may be coming to an end. BOE Governor Mark Carney has said that the time to normalize rates is now “edging closer.” The market is betting that rates, which have been kept at a historic five year low, will rise 25 basis points by February. But higher interest rates would be a double blow for UK manufactures as it would make financing investments in plant and machinery more costly. It would also cause an appreciation in sterling, making UK manufactured exports less competitive abroad. Moreover, the geopolitical situation in Iraq and the Ukraine is resulting in higher energy costs, which is a huge input cost for manufacturing. So rising energy costs could also be a headwind for UK manufacturers. Furthermore, there is the UK future relationship with the EU to consider. As Europe moves closer towards a federal Europe and the UK continues to isolate itself from it, this may deter future inward investment into UK plants and machinery. Large scale foreign investors may be put off making future investments in their UK production plants due to a fear that the UK could decide to exit from the European Union. So there’s a number of compelling reasons to be bearish about future UK production figures and it could also be factor for investors deciding to take risk off the table.
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