UK manufacturers are in demand

Manufacturers are upbeat about demand over the next three months, even though orders stayed unchanged in the quarter to July, disappointing expectations of faster growth, according to the latest Quarterly Industrial Trends survey by the

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Firms expect modest growth in domestic orders over the coming three months, are the most positive about the next quarter's export orders in over two years and are increasingly optimistic about export prospects for the coming year.

Hopes for a rise in overall demand this quarter were not met due to the continued weakness in the volume of domestic orders.

Domestic demand fell for a balance of minus five per cent of firms - disappointing expectations of a pick-up. As a result, total order book levels were broadly unchanged in the three months to July, with a balance of one per cent.

Export orders, by contrast, rose for the first time in a year, with a balance of seven per cent reporting an increase over the past three months. This was driven largely by demand for intermediate goods such as components, parts and building materials. A balance of 13 per cent of firms expect export orders to increase over the next three months; if this expectation is realised, this would see the fastest growth in export orders since 1995.

Hopes for domestic orders over the next three months remain positive, with a balance of six per cent expecting an increase.

Monthly figures suggest that manufacturers still regard order book levels as “below normal” (reported by a balance of minus 11%), a similar position to that of recent months. However, the balances between April and July were the least negative since February 2005 (-10%), and are significantly above the long-term mean value for this series of minus 22%.

The rate of manufacturing output growth picked up over the last three months, but was slower than expected as inventories were drawn down. The balance reporting an increase in output was the highest balance since October 2004 - five per cent - but significantly less than the 12 per cent expecting an increase in April.

Driven by hopes of growth in export orders, and more stable inventories going forward, the largest balance of firms since October 2004 expects to increase manufacturing output over the coming three months.

Inventories of finished goods were reduced over the past quarter by a balance of 15% of firms, indicating they have met recent demand at least in part by reducing stocks of finished goods. Stocks are now seen as little more than adequate to meet future demand, suggesting that output growth will benefit more directly from increases in orders in coming months.

Costs continue to increase rapidly, at a slightly slower pace than in recent surveys, but still exceeding expectations. The largest number of firms since January 1975 (15%) cite materials and components as a factor likely to limit output, coinciding with recent record commodity price rises.

However, hopes that firms would be able to pass on some of the rise in costs have been dashed, with output prices flat over the last three months. As a result, the squeeze on profit margins persists.

Manufacturers still continue to hope that they will be able to pass on at least some of their costs over the next three months, with modest balances saying they intend to increase domestic and export prices. The rate at which manufacturers cut jobs, to relieve the squeeze on profit margins of rising energy and commodity prices, slowed from its peak in April.

According to the survey, manufacturing jobs fell by an estimated 25,000 over the second quarter of this year - 7,000 fewer than in the previous quarter – bringing the total lost over the past year to 108,000.

Despite improving order expectations and the expected increase in output, sentiment remains subdued. On balance, manufacturers were slightly less optimistic about the business situation over the next twelve months (a balance of minus 6%), although export optimism improved for the second consecutive survey, the first sustained improvement since the first half of 2004.

In spite of a pick up in capacity utilisation (the 50% of firms working below capacity was the lowest for eight and a half years) and an increase in the number of firms reporting plant capacity a likely constraint on output, intentions for fixed investment remain weak.

A balance of minus 10% report that they intend to cut their investment in plant and machinery over the next twelve months, only marginally less negative than in recent surveys, while minus 18% intend to cut investment in buildings. Only in the areas of product and process innovation, and staff training and retraining is investment expected to rise.

Ian McCafferty, CBI Chief Economic Adviser said: “The recent improvement in the fortunes of UK manufacturers has continued to be led by exports and the strength of global demand. “If the expectations of UK firms for the near term are met, growth in export orders will rise further, to the fastest rate in a decade.

“But domestic orders remain sluggish, and it is unlikely that the current strength in the global economy will continue into 2007. As such, and with firms’ ability to generate profits under serious pressure from rising costs, there are continued question marks about the longer term health of the sector, and whether the slower pace of job losses can be sustained.”