Stagnant wages mean manufacturers should be cautious in optimism

Optimism continues to improve among manufacturers, as a low pound increases demand from the EU, however according to a new study the service sector continues to be hard hit by uncertainty and inflation, as consumers at home are hit by inflationary pressure and low real wage growth.

The UK continues to fall deeper into uncertainty, after June’s surprise election left a previously unassailable Theresa May clinging to power, having lost her Party’s majority in Parliament. With the Conservative government currently relying on an uneasy alliance with Northern Irish hardliners the DUP following the recent hung parliament, the EU meanwhile is increasingly frustrated with the UK – creating an uncertain negotiating ground for divorce proceedings, for what were already likely to be fraught negotiations.

The effect of the Brexit decision has continued to affect various segments of the market. In BDO’s May Monthly Business Trends Indices for the UK, the firm explores the recent numbers for output, optimism, inflation and employment.

UK output continued its downward trajectory in May, hitting 95.4 from 95.6 the month previous. The output slump saw levels fall to those last seen in May 2013, with the slump beginning in September of 2015.

The service sector was found by the survey to have considerable drag on the overall picture, falling from 95.3 to 95.0 between April and May – manufacturing in contrast, improved slightly, up in May to 97.7 from 97.1 the month previous.

Services continue to see lacklustre demands as consumers remained relatively subdued, while businesses themselves, in light of the General Election, have delayed actions temporarily that negatively affect their order books. Exporters have benefitted from a low pound, which has boosted their export competitiveness.

Optimism was up, the report notes, increasing by 0.3 to 102.8 in May. The increase was largely the result of the manufacturing sector, where optimism hit its highest point since late 2014 at 116.4. Service sector confidence, meanwhile, fell slightly from 100.7 in April to 100.2 in May.

The services sector is likely to face a raft of challenges this year, in light of pricing pressures, poor wage growth and falling consumer demand. Manufacturing meanwhile is enjoying demand from improved export orders – with improvement in the wider EU likely to further increase demand for exports from the UK.

While the manufacturing sector has been boosted by the recent fall in the pound, political uncertainties are still likely to negatively affect the segment in the long-term – particularly if tariffs are introduced and input inflation affects the wider supply chain.

Recent trends

The study also considered the current inflationary pressure affecting the wider market. The index found that inflation has, for the moment, plateaued at around 105 – although it remains relatively high. Annual Consumer Prince Index Inflation stood at 2.6% in April, up from 2.3% in March.

The increase in inflation was largely the result of increased costs for clothing, electricity and vehicle excise duty were up considerably, while food and non-alcoholic drinks rose annually by 1.6% to April – bucking a trend of almost two years of deflation.

The result of inflation means that in real terms, incomes are now lower than a year previous. The consequence is beginning to flow into consumer spending which is suffering, with a negative knock on effect for retailers.

The employment index has remained relatively stable, at 103.3 in May. The index level reflects relatively consistent improvements to the unemployment rate in the UK, which fell from 5.1% in May 2016 to 4.6% this year, while the employment rate hit a record high at 74.6%.

Wage growth remains sluggish however, with average earnings, up 2.1% between Q1 2016 and Q1 2017, while inflation continues to tick up. Coupled with poor productivity growth, this means that stagnant growth will hit spending power of consumers en masse in the coming months, a point also raised by Big Four consulting firm Deloitte’s Passion for Leisure study earlier this year.

In terms of long-term trends, inflation has reached levels last seen in 2012, following years of relative decline. Output has fallen sharply since a pickup in 2014, hitting levels seen between 2010 and 2013. Optimism remains relatively high, and considerably above levels in the years following the crisis. Employment, following a strong pickup in 2014-15, has fallen somewhat – although it remains well above levels seen during the deep point of the financial crisis.

Commenting on the findings, Peter Hemington, Partner, BDO, said: “Business activity in the UK’s services sector is definitely slowing down, with many blaming this on the snap election. But the downward trend is clearly much more deeply rooted than this. Surprisingly, UK businesses remain optimistic about the future, but an immediate recovery seems unlikely.”