MANUFACTURING OUTLOOK

Transcription

1 In partnership with: MANUFACTURING OUTLOOK 215 QUARTER million employees 1/2 of UK exports 72% of business R&D Average wages higher than the rest of the economy

2 Paint it Britain, image taken by Bryn Griffiths at Kineton in Warwickshire, shortlisted in the Professional category of the EEF Photography Competition 214

3 MANUFACTURING OUTLOOK QUARTER FOREWORD Lee Hopley Chief Economist EEF Richard May Head of Manufacturing DLA Piper UK LLP Welcome to the 215q3 Manufacturing Outlook report in partnership with DLA Piper. It has been an eventful summer in the world economy; while not quite four seasons in one day, we ve seen the future of the eurozone on the line once again, turbulence and uncertainty in the making in China and plenty to keep policy watchers busy with UK domestic policy. The UK data has continued to point to solid growth, but we ve been on something of a rollercoaster of risks from the rest of the world. Against this backdrop it is unsurprising, therefore, that confidence levels across UK manufacturing are starting to suffer. Looking into the next year manufacturers, are on average, less upbeat about their own growth prospects, but optimism about those of the wider UK economy have been more stable over the quarter. This undoubtedly follows from the further weakening seen across all the major indicators in our survey. The balance of manufacturers reporting output growth has dipped to its lowest level since 29q4 and at -2%, the outturn was considerable weaker than last quarter s expectations. Near term growth potential is also likely to be limited by the declines in new order intake over the past quarter. Exporters have had their worst quarter for new sales in six years and the proportion of companies seeing improving demand from Asian markets, in particular, has seen a further decline in the past three months. Moreover, domestic demand, something of a beacon in our survey over the past couple of years, isn t making up for falling overseas demand. All of this combined has brought our forward looking indicators back to earth with a bump. The picture on output and orders going into the final quarter of the year looks pretty flat. One area of resilience, however, remains companies plans to raise investment levels in the year ahead. The need to invest in new technology to increase productivity and secure longer-term growth remains on the agenda for a balance of companies in our survey. Our forecasts for the year ahead depend on businesses pressing ahead with intentions to increase investment in addition to the contribution that household spending will make to overall growth.

4 2 MANUFACTURING OUTLOOK QUARTER Q3 HEADLINES The deterioration in our survey indicators, which started at the turn of this year, has continued over the quarter. Manufacturers optimism about their growth prospects is hanging on in positive territory, but output and orders balances turned negative over the past three months for the first time since the end of 29. INDICATOR BALANCE CHANGE Confidence 6.1 ßà UK growth expectations for the year ahead stable Output -2% Output balance falls for the first time since 213q1 UK orders -9% Demand weakens further with second consecutive negative balance Export orders -9% New export orders balance falls to six year low Employment 5% Recruitment plans prove resilient as employment balance stays positive Investment 2% Investment balance fractionally down from 3% last quarter The run of positive output data from our survey over the past two years has stalled in q3 with a balance of 2% of companies reporting a fall. This is in sharp contrast to the pick-up that manufacturers had been expecting last quarter. Once again, there were some notable sectoral weaknesses, with electrical and mechanical equipment and non-metallic minerals acting as a particular drag on output over the past three months. These sectors also accounted for much of the weakness in domestic new orders. More positively, transport and electronics sectors continued to push ahead with a balance of companies reporting growth in output and total orders. Export orders continued to suffer over the quarter. The export balance had been hovering around the zero mark for around a year, but in the past three months responses fell further into the red with a balance of 9% of manufacturers seeing falling export sales the lowest balance since 29q3. There are a few bright spots on the horizon with over a third of companies seeing signs of improving demand in Europe, but the proportion of companies eyeing growth opportunities in Asia fell back in 215q3. An escalation in global risks and further declines in the oil price pushing a recovery in investment further out have dented manufacturers confidence about the year ahead. The firm level confidence indicator edged down again, but there seems to be enough optimism around for companies to maintain investment levels and increase employment. These provide two reasons for cheer in an otherwise disappointing set of indicators. FIRM LEVEL CONFIDENCE EDGES DOWN AGAIN CONFIDENCE IN THE NEXT 12 MONTHS 1 = SUBSTANTIALLY WORSE, 1 = SUBSTANTIALLY BETTER q3 Business performance UK economic conditions 214q4 215q1 215q2 215q3

5 MANUFACTURING OUTLOOK QUARTER OUTPUT The output balance turned negative (-2%) in q3 for the first time in over two years. This follows the drop in manufacturing output in q2 Official Statistics which ended a run of eight consecutive quarters of growth. The negative balance mainly reflects a renewed deterioration in global economic conditions weighing on exports, combined with a persisting weakness in the domestic oil & gas sector. Expectations for the next three months remain positive at 1%, albeit significantly muted compared to previous quarters. PAST THREE MONTHS -2% NEXT THREE MONTHS 1% Output balances have been progressively tailing off since 214q4 as market conditions are becoming increasingly challenging for British manufacturers. Developments in the world economy over the past three months have dealt a further blow to output growth in the globally-focused manufacturing sector. Similar to previous quarters, sectoral divergence remains a key theme, with weakness in the mechanical equipment sector acting as a significant drag in the results. The sector continues to suffer from weak activity in the North Sea oil & gas sector where recent price volatility will do little to restart investment. The sector is also facing a double whammy from the slowdown in China where demand for investment goods is dwindling at the same time that a devaluated yuan is boosting the competitiveness of Chinese exports. The electrical equipment and non-metallic mineral sectors have also seen output fall linked to subdued oil & gas activity for the former and weaker than expected growth in the construction sector for the latter. OUTPUT BALANCE TURNS NEGATIVE AFTER NINE QUARTERS OF GROWTH % BALANCE OF CHANGE IN OUTPUT 35 % q4 211q1 211q2 211q3 211q4 OUTPUT SUMMARY 212q1 % BALANCE OF CHANGE 212q2 212q3 212q4 213q1 213q2 213q3 213q4 214q1 214q2 214q3 214q4 215q1 215q2 215q3 Next 3 months SECTOR PAST 3 MONTHS NEXT 3 MONTHS Basic metals -32 Metal products 6 22 Mechanical Electrical Electronics 11 5 Motor vehicles Other transport 11 TURNOVER -9m m m and over On the other hand, the motor vehicles sector continues to post solid growth benefiting from stronger household consumption in both home and abroad. The food & drink sector also saw positive output balances in q3 with low inflation and rising wages continuing to support consumer demand.

6 4 MANUFACTURING OUTLOOK QUARTER ORDERS Total orders continued on their downward trajectory in q3, turning negative for the first time since 213q1. Both UK and export orders came at -9% reflecting a further deterioration in demand from both the domestic market and overseas. The weak intake in orders in q3 is also affecting expectations for the next three months, although some improvement is expected, particularly in UK orders. DEMAND CONTINUES TO WANE % BALANCE OF CHANGE IN ORDERS 4 % UK orders Export orders Total orders q4 211q1 211q2 211q3 211q4 212q1 212q2 212q3 212q4 213q1 213q2 213q3 213q4 214q1 214q2 214q3 214q4 215q1 215q2 215q3 Next 3 months UK ORDERS PAST 3 MONTHS -9% NEXT 3 MONTHS 3% EXPORT ORDERS PAST 3 MONTHS -9% NEXT 3 MONTHS -4% TOTAL ORDERS PAST 3 MONTHS -6% NEXT 3 MONTHS 1% UK ORDERS Despite the overall strength of the domestic market, UK orders have been notably weak throughout 215. Continuing the trend seen in previous quarters the weakness is largely concentrated in manufacturing sectors embedded in the oil & gas supply chain. The mechanical equipment sector once more stands out; the sector is bearing the brunt of the collapse in oil & gas activity as well as the overall softening of investment levels in the economy. The electrical equipment sector is also exposed to the North Sea and has seen UK orders falling sharply in q3 after reasonable performance in the first half of 215. Similarly the basic metals sector saw orders come flat in q3; the negative sentiment in the sector is reflected in expectations of a large drop in UK orders in the next three months. The flip side of this is that the low oil price keeping inflation at bay is supporting consumer-facing sectors. The food and drink and motor vehicle sectors have been the main beneficiaries of a strengthened British consumer. Demand in these sectors has held up and is expected to remain strong in the next three months. Robust demand for motor vehicles is also driving UK orders for rubber and plastics and in turn for chemicals further down the supply chain. Overall, manufacturers expect UK orders to come off their trough in the last quarter of the year and continue to support sectors catering to the domestic market.

7 MANUFACTURING OUTLOOK QUARTER DEMAND FROM EUROPE HOLDS UP DESPITE GREEK CRISIS % OF COMPANIES REPORTING IN CHANGE IN DEMAND BY MARKET % Africa Asia EXPORT ORDERS Europe Middle East North America South America No notable pick-up in demand While the year started with optimism among manufacturers that exports could be turning a corner in 215, global events have quickly caught up to put a dent on that confidence. After a zero balance q2, responses on export orders have seen a sharp decline this quarter. Our results suggests that the solid performance of goods exports seen in Official Statistics in q2 is unlikely to be replicated in the second half of the year. The global economy took a wrong turn during q3, with the re-escalation of the Greek crisis in eurozone and events in China, weighing on export demand. While demand from the eurozone has held up, the slowdown in China is having a dampening effect on exports, particularly for investment goods such as mechanical equipment. The strong Sterling exchange rate is also hurting exports in commoditised sectors like basic metals, which are already facing intense competition from low-cost producers. On the other hand, the main bright spots continue to be electronics and motor vehicles. The US continues to be a steady source of demand for these sectors while the upside surprise in the eurozone is improving their export prospects. Still, manufacturers reported a slowdown in demand from Asia and our results suggest that manufacturers are gearing up for a further slump in the next three months. The elevated uncertainty in the global economy has taken its toll on manufacturer s expectations for overseas sales in the next quarter. This marks a notable change from our previous reports where manufacturers have consistently reported positive forward looking balances. The balance turned negative for the first time since 211q4 pointing to some sizeable challenges for exporters in the final quarter of 215. ORDERS SUMMARY % BALANCE OF CHANGE UK ORDERS EXPORT ORDERS TOTAL ORDERS SECTOR PAST 3 MONTHS NEXT 3 MONTHS PAST 3 MONTHS NEXT 3 MONTHS PAST 3 MONTHS NEXT 3 MONTHS Basic metals Metal products Mechanical Electrical Electronics Motor vehicles Other transport TURNOVER -9m m m and over

8 6 MANUFACTURING OUTLOOK QUARTER EMPLOYMENT & INVESTMENT The balance of companies reporting increased employment took a step down in the past three months. The employment balance was the lowest in more than two years but our survey indicates the pace of job growth will pick up marginally in the next three months. Investment intentions weakened further. The balance of companies planning to raise investment spending has dropped to 2% from 3% in the previous quarter. INVESTMENT INTENTIONS DROP TO THE WEAKEST IN MORE THAN FIVE YEARS % BALANCE OF CHANGE % 21q4 211q1 211q2 211q3 Investment intentions 211q4 212q1 212q2 212q3 212q4 213q1 213q2 213q3 Employment 213q4 214q1 214q2 214q3 214q4 215q1 215q2 215q3 Next 3 months EMPLOYMENT PAST 3 MONTHS 5% NEXT 3 MONTHS 6% INVESTMENT NEXT 12 MONTHS 2% A positive balance of manufacturers continued to increase headcount across their UK activities in the past three months. At 5%, the balance was down from last quarter, pointing to a continuation of the recent slowdown in employment growth seen in official data. Manufacturers across most turnover brackets except medium-sized companies posted positive employment balances, with larger companies more likely to have taken on new employees over the quarter. There were also some differences across sub-sectors, with manufacturers of non-metallic minerals and mechanical equipment on balance, reducing headcount in the past three months. Plans for further increases in employment have eased, but at 6% the forward looking balance remains above the historic average for the series. The resilience of employment could be due to companies in some sectors struggling to fill vacancies because of skills shortages. Investment intentions continued to deteriorate, with the weakness concentrated in the electrical equipment sector. The overall balance of 2% represented a sharp decline compared with the start of the year, yet was still relatively strong compared with historic trends. Slower economic growth in China, or renewed uncertainty about whether Greece will exit the euro, may have played a role. EMPLOYMENT AND INVESTMENT SUMMARY % BALANCE OF CHANGE EMPLOYMENT INVESTMENT SECTOR PAST 3 MONTHS NEXT 3 MONTHS NEXT 12 MONTHS Basic metals Metal products Mechanical Electrical Electronics Motor vehicles Other transport TURNOVER -9m m m and over

9 MANUFACTURING OUTLOOK QUARTER PRICES & MARGINS EXPORT MARGINS DETERIORATE SHARPLY % BALANCE OF CHANGE Factory gate price inflation has picked up but remains subdued, with official data showing core output prices increasing by only.3% in the year to July. Our latest survey reveals a weaker picture, with the balance on UK prices falling sharply back into negative territory in the past three months. The balance on export prices in the quarter also dropped back. At the same time, more companies reported a worsening in export margins over the past three months, while the negative balance in UK margins was unchanged. 3 % q4 211q2 UK prices UK margins 211q4 212q2 212q4 Export prices Export margins 213q2 213q4 214q2 214q4 215q2 % Next 3 months UK PRICE PAST 3 MONTHS -11% NEXT 3 MONTHS -4% EXPORT PRICE PAST 3 MONTHS -13% NEXT 3 MONTHS -1% UK MARGINS PAST 3 MONTHS ßà -14% NEXT 3 MONTHS -1% EXPORT MARGINS PAST 3 MONTHS -32% NEXT 3 MONTHS -23% The balance of companies reporting change in prices on UK sales was negative over the past three months, and at -11% was a deterioration on last quarter s balance of +1%. Downward price pressures remain evident in sectors such as electrical equipment and basic metals, with competition and lower input costs flowing from weak prices for global commodities particularly for the latter holding down price rises. Responses on export prices have weakened over the quarter, with an overall balance of 13% of manufacturers reporting falling prices, up from 6% over the previous three months. The greatest weakness was concentrated in the basic metals, chemicals and electrical equipment sectors. Consequently, margins remained under pressure over the past three months. A balance of 14% of companies reported a decline in UK margins, the same as in the second quarter of the year. Yet the squeeze on export margins has intensified, with a balance of 32% seeing a decline in export margins, compared to 24% in the previous period. Slower economic growth in the euro zone which contains key destinations for UK exports and China, along with the pound appreciating to a seven-year high on a trade-weighted basis, are likely to have contributed to the weaker export margins. Manufacturers remain pessimistic about the prospects for rebuilding profits, especially on overseas sales, in the next three months. ALL SECTORS FEEL THE SQUEEZE % BALANCE OF CHANGE IN EXPORT MARGINS IN THE PAST THREE MONTHS 6 % Basic metals UK prices Export prices Metal Mechanical Electrical Electronics products Motor vehicles Food & drink Chemicals

10 8 MANUFACTURING OUTLOOK QUARTER REGIONAL TRENDS The regional picture has become more nuanced since our last Outlook report. A number of regions are facing a more challenging business environment in q3 reflected in an increase in negative responses for output and orders. Still, positive recruitment and investment intentions remain in place for most regions in the UK. ßà á á J 6. á J 6.26 á á á J 6.4 á á J 6.34 á J 6.39 J 6.2 á á J 6.57 á J 6.26 J 7.8 KEY: á/ INCREASE/DECREASE ON PREVIOUS QUARTER OUTPUT EMPLOYMENT INVESTMENT J BUSINESS CONFIDENCE Source: National Statistics

11 MANUFACTURING OUTLOOK QUARTER The softening of the momentum in the manufacturing sector has mapped across the majority of UK regions with output and order balances waning compared to the previous quarter. Export demand has been a weak spot for most regions while poor domestic order books are largely confined to regions along the Northern border, where there is a high concentration of manufacturers supplying to the North Sea oil & gas sector. The South East and London continues to post strong balances in all key indicators while Scotland is persistently lagging behind as the region s dominant oil & gas industry continues to struggle. Expectations for the next quarter are evenly split between regions that expect a better end to the year and those that don t. BUSINESS CONFIDENCE INDICATORS Developments in the global economy have unsurprisingly affected confidence levels among UK manufacturers. Both our headline confidence indicators have progressively tailed off since 215q1. Overall, manufacturers remain optimistic about the UK economy and their own business prospects, albeit more elevated levels of uncertainty are evident in the results. REGIONS REMAIN OPTIMISTIC DESPITE MOUNTING UNCERTAINTY CONFIDENCE IN THE NEXT 12 MONTHS 1 = SUBSTANTIALLY WORSE, 1 = SUBSTANTIALLY BETTER North East North West Business Yorks & Humber East Mids UK economy Eastern SE & London South West West Mids Wales UK average Nevertheless six out of ten regions are reporting an increase in confidence in their own business prospects compared to q2, supporting manufacturers recruitment and investment plans over the next 12 months. REGIONAL SUMMARY % BALANCE OF CHANGE SECTOR PAST 3 MONTHS OUTPUT TOTAL ORDERS EMPLOYMENT NEXT 3 MONTHS PAST 3 MONTHS NEXT 3 MONTHS PAST 3 MONTHS NEXT 3 MONTHS Scotland North East North West Yorks & Humber East Mids Eastern South East & London South West West Mids Wales

12 1 MANUFACTURING OUTLOOK QUARTER ECONOMIC ENVIRONMENT UK economic growth picked up to.7% in the second quarter, from.4% previously. The main growth driver was net exports, while business investment made the largest contribution in a year. Yet manufacturing fell for the first time in more than two years: uncertainty as to whether Greece would leave the eurozone, and the stronger pound, probably played a part in the weak performance. We expect the economy to grow 2.5% this year, revised down by one-tenth of a percentage point from last quarter s forecast. UK HEADLINES Economic growth is set to moderate to 2.5% in 215 Stronger real wage growth should support private consumption Exports will remain under pressure Official interest rates likely to start rising in early 216 PRIVATE CONSUMPTION LIKELY TO REMAIN THE KEY GROWTH DRIVER The second estimate of UK GDP in the three months to June saw strong rises in exports and business investment. Manufacturing continued to struggle however, falling.3% after rising only.1% in the first quarter. Private consumption remained a key growth driver. Consumer spending has benefited from high employment and strong real wage growth. The employment rate recently hit a record high. The annual inflation rate has hovered around zero which, along with average earnings excluding bonuses accelerating to a six-year high, lifted real wage growth. Looking ahead, private consumption is set to stay as the main growth driver. The recent renewed weakness of crude oil prices will probably support private consumption because the UK is a net oil importer: the resulting lower prices for imported petrol and diesel should boost households purchasing power. UK ECONOMIC FORECASTS % CHANGE EXCEPT WHERE STATED Trading environment Exchange rate ( / ) Exchange rate ($/ ) Exports Imports Current account (% GDP) Output Manufacturing GDP Costs and prices Average earnings Oil price (Brent Oil $/bl) Employment Manufacturing (s) 2,557 2,597 2,625 2,599 Rest of economy (s) 29,712 3,746 31,79 31,342 Unemployment rate (%) Source: Oxford Economics and EEF Also, real wage growth is set to pick up further as the labour market runs out of slack and inflation rises only gradually. Inflation is expected to climb to around 2% by late 217, largely driven by domestic demand-driven pressures. The Bank of England is expected to start raising interest rates in early 216 as it targets inflation of 2% in one to two years time. When interest rates do start to rise, they are unlikely to weigh heavily on private consumption because policymakers have flagged they will be small, gradual, and a peak lower than in previous monetary policy tightening cycles. The scope for a pickup in exports is limited with the eurozone s recovery only expected to gain momentum gradually. Also, the pound is set to strengthen further against the euro as the outlook for growth and the prospect of monetary policy tightening are more favourable in the UK than in the eurozone. The risks to the UK outlook are weighted to the downside. Key threats include a sharp slowdown in China triggering a major global downturn, hitting UK exports hard.

13 MANUFACTURING OUTLOOK QUARTER GLOBAL ECONOMIC OUTLOOK DOWNGRADED Global growth outlook weaker Fears of a sharp slowdown in China US Fed likely to delay raising Funds rate China s shadow banks are a key risk Global growth is expected to slow this year but remain firm, with China the main drag. The global economy is likely to expand 3.1%, revised down one-tenth of a percentage point from last quarter s forecast. CHINA S CONTRIBUTION TO GLOBAL GROWTH WANES The pace of China s growth is set to decelerate to the weakest in more than two decades. The government is targeting official real GDP which typically overstates economic activity to rise 7% this year, down from 7.4% last year. We expect official GDP will rise 6.6% but the true increase will probably be lower. Growing fears about the severity of the slowdown recently triggered sharp falls in Chinese stock markets, despite the government temporarily buying equities to try and halt the sell-off. Chinese policymakers are struggling to rebalance the growth drivers toward private consumption and away from fixed investment. Private debt surged to around 18% of GDP in 214, higher than that of the US, the eurozone and Japan. Fears that strong credit growth was fuelling asset price bubbles prompted authorities to tighten controls on official banks, pushing up interbank lending rates. The resulting higher cost of consumer and mortgage credit has weighed on an already over supplied housing market. The declines in house prices and equities are likely to reduce households perceived wealth, discouraging private consumption. Yet the renewed weakness of crude oil prices should support private consumption as China is a net oil importer. China recently ranked as the world s fourth largest net oil importer, after the US, the eurozone and Japan. At the same time, the tighter controls led to an increase in borrowing from shadow banks, that is, non-bank financial intermediaries such as investment management firms that provide services similar to traditional banks. The greater reliance on shadow banks, which are difficult to regulate because they lack transparency, makes China s financial system vulnerable to shocks. CHINA SPOTLIGHT China s growth slowdown has recently fuelled fears about the potential impact on the UK economy. As trade is the main linkage between the two economies modelling the impact on the UK of a fall in China s total imports should provide guidance. Our macroeconomic model was shocked with a drop of 12% in China s total imports in 215, which is equivalent to the decline during the Asian financial crisis in the late 199s. The results showed that the decline in China s imports would weigh on UK real GDP, manufacturing output, and manufactured exports in 215 and 216. The model estimated that the drag on real GDP and manufacturing output would be around.3 percentage points in 216. The impact on manufactured exports is more sizeable at around 1.2 percentage points lower in 216. IMPACT ON THE UK OF A 12% FALL IN CHINA S IMPORTS SCENARIO % CHANGE Base case Scenario Base case Scenario Real GDP Manufacturing output Total exports Goods' exports Source: Oxford Economics

14 12 MANUFACTURING OUTLOOK QUARTER The authorities recently allowed China s currency to devalue to a four-year low against the US dollar, signalling they are pulling out the stops to hit this year s official GDP target. The devaluation should improve the cost competitiveness of China s exports. Also, policymakers have eased monetary policy since last year to support growth and are likely to continue to do so. DEVELOPED ECONOMIES UNABLE TO FILL CHINA S SHOES Economic growth in the US is likely to be little changed from 214 at around 2.3%. Private consumption is likely to benefit from strong job gains and rising wages. Also, healthy corporate balance sheets should encourage businesses investment. Yet exports will probably remain under pressure from the strong dollar. The outlook for growth and the prospect of monetary policy tightening are more favourable in the US than most major economies, suggesting the dollar will appreciate further. The Federal Reserve was widely expected to increase the Funds rate in September but the recent volatility in Chinese and global stock markets suggests this could be postponed until December. The eurozone s real GDP growth is forecast to pick up to 1.4% this year from.9% in 214. High debt in a number of eurozone member countries is likely to maintain the pressure on households and governments to pay off existing liabilities, dragging on the recovery. Yet Greece s new three-year 86 billion bailout should reduce the prospect of the nation leaving the eurozone, supporting consumer and business confidence throughout the region. The risk that Greece s snap general election on September 2 will throw a spanner in the works is low. The ECB is expected to keep monetary policy accommodative to support the recovery, with the main interest rate remaining at its record-low near zero for a prolonged period. The bank s quantitative easing program involving purchasing 6 billion of sovereign debt every month is due to end in September 216 but there is a chance it will be extended. Japan s economy is expected to expand.8% this year, after contracting slightly in 214. Real GDP fell 1.6% on an annualized basis in the second quarter on the back of declines in private consumption, business investment and net exports. Growth should get back on track in the second half of the year. Private consumption is likely to continue to recover from last year s increase in consumption tax, and as households bring forward purchases ahead of the next consumption tax increase in April 217. Japan s central bank is likely to further boost its quantitative easing program later this year to support the economy. The risks to the global outlook are also skewed to the downside. The main threats include a sharp slowdown in China s growth triggering a run on shadow banks. This could jeopardise financial stability and cause a major global downturn if the government is unwilling or unable to bail them out. Also, a disconnection between when investors expect the US Funds rate starts to rise, and when it actually does so, could trigger financial market volatility. INTERNATIONAL ECONOMIC FORECASTS % CHANGE EXCEPT WHERE STATED GDP INFLATION France Germany Japan US Eurozone China India World (21 PPPs) CHINA S ECONOMIC GROWTH HAS SLOWED REAL GDP % CHANGE 16 % Source: Oxford Economics Source: National Statistics Bureau of China

15 MANUFACTURING OUTLOOK QUARTER SECTOR FORECASTS The continued weakness in manufacturing has asserted itself on many sectors, evidenced in a fairly broad-based slowdown in this quarter s Manufacturing Outlook survey. However, the reasons for this slowdown are diverse. A weakening picture in China has presented challenges for a number of manufacturing sectors, reducing export demand and in some cases exacerbating price pressures linked to a stronger sterling. Although the domestic market remains a bright spot, not all manufacturers have benefited, with those in oil and gas supply chains continuing to face weak demand. Once again, however, the transport sectors have proved tenacious and should continue to post robust growth in 215. MOTOR VEHICLES SEND HIGHEST PROPORTION OF EXPORTS TO CHINA INDEX, MANUFACTURING AVERAGE = 1) Motor vehicles Textiles Mechanical equipment Electrical equipment Pharmaceuticals Electronics Metal products Basic metals Chemicals Rubber and plastics Non-metallic minerals Food and drink % Source: uktradeinfo STERLING A CHALLENGE IN MORE COMMODITISED SECTORS In more commoditised manufacturing sectors for example basic metals and rubber and plastics the strength of sterling has been hurting margins on exports. This is particularly damaging for the basic metals sector, as its challenges have been compounded by weak demand, and subsequently increased metals exports, from China. This has pushed down the price of metals, and made margins extremely challenging for manufacturers in the sector. Overall we expect output to fall 2.9% in 215. For rubber and plastics, weakness in the first half of the year linked both to a strong sterling as well as volatile input prices means that output will fall across 215 as a whole. However, this weakness should be shrugged off in the second half of the year, as fundamentals for the sector remain strong, with its key sectors, construction and motor vehicles still set to grow. CONSUMER-FOCUSED SECTORS FACE POSITIVE DEMAND, BUT GROWTH LIMITED BY OTHER PRESSURES The food and drink sector should benefit from positive UK consumption trends. Supermarket price wars have put pressure on margins for some dampening the first half of the year, and meaning our forecast shows a dip across 215 as a whole however, prospects remain positive and growth is likely to return in q3, with the Rugby World Cup poised to provide a boost. Although UK construction growth has slowed at the start of 215 compared with 214, which may be something of a concern for the non-metallic minerals sector, longer term forecasts suggest the construction recovery should continue to broaden, providing a good grounding for growth. We expect output in non-metallic minerals to increase by 3.1% this year and 2.2% in 216. OIL AND GAS-EXPOSED SECTORS FAIL TO SEE DOMESTIC BOOST The strength of the UK economy has eluded manufacturers in sectors serving the oil and gas supply chain. Manufacturers of mechanical equipment and electrical equipment continue to report weak demand in our survey. Mechanical equipment, in particular has had a very weak start to the year with output falling 6.6% in q1 and 2.% in q2. Looking ahead, as well as the impact of weakness in demand from oil and gas, the sector is also somewhat exposed to a slowdown in demand for investment goods from China. We now expect output in mechanical equipment to contract by 11% over 215 as a whole.

16 14 MANUFACTURING OUTLOOK QUARTER SECTOR FORECASTS The picture for electrical equipment is less stark, due to its greater breadth of exposure to sectors outside of oil and gas. We continue to expect a contraction of 1% this year, with modest growth in 216, as some large scale construction projects come on stream. SECTORS WITH DIVERSE DEMAND SEE A BALANCED PICTURE The metal products and chemicals sectors both have diverse industrial demand bases that should support sustained growth in 215, with output expanding 3.8% and 4.5% respectively. Both sectors also face only limited exposure to China which should reduce risks to growth associated with a slowdown in the world s second largest economy. Nonetheless, with the overall global picture also set to be more subdued, these broad sectors are unlikely to be unaffected and we forecast slower growth rates in 216. The electronics sector also has a diverse demand base, and it should benefit from a solid picture in the US and Europe. However, output dipped markedly in the first quarter of 215. This, combined with its higher exposure to China through direct and indirect exports means that growth is less assured. As such we expect slow growth of.3% in the electronics sector this year. GROWTH IN TRANSPORT SECTORS CONTINUES APACE The transport sectors have long been a source of positivity, and this looks set to continue for both motor vehicles and other transport. Growth in car production has continued apace and strong domestic demand has been complemented by an improving export picture. Although the motor vehicles sector does have high levels of exposure to China which presents a risk to growth a slow and steady turnaround for the European consumer, combined with new models moving into production in the next few months, should see growth sustained throughout 215. Similarly, output in the other transport sector continues to expand to meet existing orders backlogs. After a strong second quarter we have revised up our forecasts to show growth of 1.4% this year. SECTOR GROWTH RATES AND FORECASTS % CHANGE OUTPUT EMPLOYMENT Basic metals Metal products Mechanical Electronics Electrical Motor vehicles Other transport Food and drink Chemicals Pharmaceuticals Rubber and plastics Non-metallic minerals Paper and printing Textiles Manufacturing Source: EEF and Oxford Economics

17 MANUFACTURING OUTLOOK QUARTER HISTORIC MANUFACTURING TRENDS OUTPUT GROWTH TURNS NEGATIVE % BALANCE OF CHANGE IN THE PAST THREE MONTHS AND % CHANGE ON A YEAR AGO EXPORTS CONTINUE TO GROW SOLIDLY IN Q2 MANUFACTURED EXPORTS, VALUE ( M) 4 % Output Orders ONS (RHS) , 6, 55, 5, 45, 4, 35, 25Q3 26Q3 27Q3 28Q3 29Q3 21Q3 211Q3 212Q3 213Q3 214Q3 215Q3 and ONS MANUFACTURERS PRESS ON WITH RECRUITMENT PLANS % BALANCE OF CHANGE IN THE PAST THREE MONTHS AND % CHANGE ON A YEAR AGO 4 % Q3 26Q3 27Q3 28Q3 EEF 29Q3 21Q3 ONS (RHS) 211Q3 212Q3 213Q3 214Q3 215Q and ONS WHOLE ECONOMY PRODUCTIVITY GROWTH PICKS UP IN Q1 OUTPUT PER HOUR, ANNUAL % CHANGE 1 % Whole economy Manufacturing Q1 26Q1 27Q1 28Q1 29Q1 21Q1 211Q1 212Q1 213Q1 214Q1 215Q1 25Q2 26Q2 27Q2 28Q2 29Q2 21Q2 211Q2 212Q2 213Q2 214Q2 215Q2 UK MANUFACTURING CATCHES UP IN 214 MANUFACTURING GVA, ANNUAL % CHANGE and ONS 25 % United States Germany France United Kingdom Source: OECD INVESTMENT CONTINUES TO GROW BUT PACE SLACKENS % BALANCE OF CHANGE IN THE PAST THREE MONTHS AND % CHANGE ON A YEAR AGO 3 % ONS BTS (RHS) % Q3 26Q3 27Q3 28Q3 29Q3 21Q3 211Q3 212Q3 213Q3 214Q3 215Q3 Source: ONS and ONS

18 16 MANUFACTURING OUTLOOK QUARTER INTERNATIONAL PERSPECTIVE FROM DLA PIPER BUSINESS OPPORTUNITIES IN IRAN ARE YOU PROPERLY EQUIPPED TO JOIN THE RACE? This summer saw the long awaited signing of a Joint Comprehensive Plan of Action (JCPOA) between the E3+3 (the UK, France, Germany, China, the Russian Federation and the US), the European Union and Iran. Iran has agreed to implement a series of commitments in relation to limiting its nuclear programme in return for a phased lifting of UN, EU and US sanctions. EU and US sanctions relief will be provided through the suspension and eventual termination of sanctions measures, beginning only if and when the International Atomic Energy Agency verifies that Iran has implemented key nuclear-related measures. Under the terms of the JCPOA, sanctions will be progressively phased out in areas including: oil and gas, including trade in Iranian-origin product and the supply of equipment for the oil and gas industry; transfers of funds and banking activities; financial support for trade (e.g. export credit and guarantees, export insurance); transport (sea and air); trade in diamonds, precious metals, graphite and certain raw and semi-finished metals; delivery of Iranian banknotes and coins; and, the provision of US dollar banknotes to the Government of Iran. OPPORTUNITIES FOR UK COMPANIES IN IRAN? As European business gears up for a post-sanctions environment and the strengthening of relationships with Iran, many UK companies face mixed messages with regards to what they can and cannot do under the existing sanctions framework and how to prepare for substantial new trade and investment opportunities in Iran. Relevant authorities, including the UK HM Treasury, have confirmed that existing sanctions will continue to be robustly enforced. Against this backdrop, the UK Foreign Secretary has made a clear commitment to supporting British businesses who wish to engage with Iran stating that As that economic re-engagement materialises, we will, of course, seek to assist UK businesses to take advantage of the opportunities that will arise. As a significant and diverse emerging market, increased trade and investment with Iran the Middle East s third largest economy presents substantial opportunities for European business. Manufacturing companies, especially those in the automotive, aerospace, technology and industrial sectors are eyeing up how to take advantage of the potential opening up of trade and investment opportunities, currently held back by a decade of sanctions measures. DLA Piper is advising clients interested in assessing both the current and future legal framework with regards to the possibility of engaging in the Iranian market. Companies considering Iran are well advised to start preparing now for the wider potential opportunities that will be delivered as sanctions are lifted. It is important to reiterate however that although a number of UK companies are either already engaged in Iran or well advanced in their planning for re-engagement in a post-financial and economic sanctions Iran, wide ranging restrictive measures remain in place and will continue to be rigorously enforced. Any easing of sanctions on Iran will only happen once specified steps have been taken in relation to Iran s nuclear capabilities. Provided that the Iranian regime adheres to its commitment and sanctions are gradually phased out, EU Governments appear committed to assisting business and the financial sector to promote trade and investment. John Forrest Head of International Trade john.forrest@dlapiper.com

19 MANUFACTURING OUTLOOK QUARTER ABOUT EEF EEF is dedicated to the future of manufacturing. Everything we do is designed to help manufacturing businesses evolve, innovate and compete in a fast changing world. With our unique combination of business services, government representation and industry intelligence, no other organisation is better placed to provide the skills, knowledge and networks they need to thrive. We work with the UK s manufacturers from the largest to the smallest, to help them work better, compete harder and innovate faster. Because we understand manufacturers so well, policy makers trust our advice and welcome our involvement in their deliberations. We work with them to create policies that are in the best interests of manufacturing, that encourage a high growth industry and boost its ability to make a positive contribution to the UK s real economy. Our policy work delivers real business value for our members, giving us a unique insight into the way changing legislation will affect their business. This insight, complemented by intelligence gathered through our ongoing member research and networking programmes, informs our broad portfolio of services; services that unlock business potential by creating highly productive workplaces in which innovation, creativity and competitiveness can thrive. To find out more about this report, contact: Lee Hopley Chief Economist lhopley@eef.org.uk George Nikolaidis Senior Economist gnikolaidis@eef.org.uk Felicity Burch Senior Economist fburch@eef.org.uk Zach Witton Deputy Chief Economist zwitton@eef.org.uk EEF Information Line research@eef.org.uk The data used in this survey has been provided by EEF members. Contributing to our surveys helps to accurately reflect trends and behaviours that shape the UK manufacturing sector. If you would like to participate in future surveys, please contact Amanda Norris in our Information and Research team anorris@eef.org.uk ABOUT DLA PIPER DLA Piper is a global law firm with lawyers located in more than 3 countries throughout the Americas, Asia Pacific, Europe and the Middle East, positioning it to help companies with their legal needs anywhere in the world. At DLA Piper we take our expertise in and commitment to the manufacturing sector very seriously. We have built a strong reputation for supporting organisations engaged in all aspects of manufacturing. We are committed to understanding the markets our clients operate in and the specific commercial challenges you face. Our international team of lawyers has considerable experience of working with a broad range of blue chip manufacturing businesses, both in the UK and internationally. Supporting our manufacturing clients with issues across all aspects of business from products, operations, customers, people, finance and risk, governance and compliance. To talk about any issues your manufacturing business may be facing please contact: Richard May Head of Manufacturing richard.may@dlapiper.com Bronwen McLaughlin Marketing & Business Development Manager, Manufacturing bronwen.mclaughlin@dlapiper.com For further information about our organisation and services, please visit our website: Published by EEF, Broadway House, Tothill Street, London SW1H 9NQ Copyright EEF September 215

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