SME Monitor Q aldermore.co.uk

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1 SME Monitor Q aldermore.co.uk

2 aldermore.co.uk

3 Contents Executive summary UK economic overview SME inflation index one year review SME cost inflation trends SME business confidence SME credit conditions UK business insolvencies Appendix: cost base analysis Contact and methodological note This report was produced by Centre for Economics and Business Research (Cebr) for Aldermore. Cebr is not licensed in the conduct of investment business as defined in the Financial Services and Markets Act Any client considering a specific investment should consult their own broker or other investment adviser. Any views on investments expressed by Cebr, or on behalf of Cebr, are intended to be generic only. Cebr accepts no liability for any specific investment decision which must be at the investor s own risk. Whilst every effort has been made to ensure the accuracy of the material in this report, neither the authors nor Cebr will be liable for any loss or damages incurred through the use of this report or associated materials. SME Monitor Q

4 Annual cost inflation among UK SMEs accelerated to 1.1% in the first quarter of Executive Summary Cost inflation among the UK s small and medium-sized enterprises (SMEs) accelerated to 1.1% year-on-year according to the latest data from Q This is up from both its rate in Q (1.0%) and from the same quarter a year ago (0.9%). The uptick in inflation was chiefly driven by higher wage growth. This was especially the case for the construction sector, where employment costs make up over 40% of total costs, and where wages grew faster than in the economy on average at a pace of 2.9%. The effect of rising wage costs was slightly offset by falling costs elsewhere. In particular, commodity prices such as chemicals, metals, and gas recorded a fall. This was largely driven by a slowdown in emerging markets pushing down the demand for commodities, a trend that is set to continue. As a result, annual cost inflation among manufacturing SMEs, who use such inputs intensively, was the lowest among all sectors. This pick-up in inflation comes alongside a general economic uptick. Most major economic indicators have been showing robust improvement in recent months, culminating with strong GDP growth figures for the first quarter of the year. The economy was reported to have expanded by 3.1% year-on-year in Q1, the fastest annual growth seen since Leading indicators such as the ICAEW/Grant Thornton Business Confidence Monitor suggest the strong growth we have seen so far is set to continue this year, leading to an average rate of expansion of 3.0% over 2014 as a whole. However, an interest rate rise looms in the horizon as the Bank of England responds to rising inflation, raising the cost of credit to UK SMEs. This compares with 1.0% in Q4 2013, and with 0.9% a year ago. Rising wage costs provided the greatest contribution to this rise in inflation. These were in turn driven by the UK s improving labour market. Cost inflation was highest in the construction sector, while SMEs in the manufacturing sectors saw their costs stay broadly unchanged. SME Monitor Q

5 The UK achieved GDP growth of 0.8% in the first quarter of 2014 SME Monitor Q

6 UK to emerge as fastest-growing G7 economy in 2014 The UK achieved GDP growth of 0.8% in the first quarter of This leaves the size of the economy just 0.6% below the peak seen in Q1 2008, and it looks increasingly likely that this pre-crisis peak will be exceeded in the second quarter of UK annual GDP growth 5% 4% 3% Source: ONS Cebr Analysis A surge in business investment shown in the latest data provides an encouraging sign for the long term path of the UK recovery, as investment is an important driver of sustainable growth and helps boost productivity. We expect the economy as a whole to expand by 3.0% over the year, supported by increased levels of business investment and household consumption. This suggests that the UK could be the fastest growing G7 economy this year. Further down the line we expect growth to slow to 2.3% in 2015 as fiscal consolidation becomes an inevitable task for the next parliament. 2% 1% 0% -1% -2% -3% -4% -5% -6% Forecast UK economy expected to expand by 3% in SME Monitor Q

7 SME inflation index one year review The UK economy saw a remarkable turnaround over the past year. After staring down the barrel of a triple-dip recession at the beginning of 2013, it has now reached a point where it is growing at its fastest annual rate since the financial crisis according to the latest data for Q Interestingly, the acceleration in economic expansion and consumer and business confidence has not come alongside increasing cost pressures. Cost inflation for the UK s small and medium enterprises (SMEs) in particular has remained broadly steady in the past year. The annual rate of SME cost inflation was 1.1% in Q1 2014, compared to 0.9% in Q Although headline SME inflation has held fairly steady, the drivers of inflation have changed over the past year. A year ago, the biggest contribution to SME cost inflation came from rises in physical inputs costs. This was partly offset by constrained wage growth on the back of a weak economic environment. In the latest data however, this picture has been largely reversed. Wage growth while remaining fairly subdued - was higher than overall SME cost inflation as a whole in Q1 2014, helping drive the marginal uptick in the index compared to previous periods. The offsetting factor this time was falling commodity prices, which were in turn driven by a slowdown in emerging markets. Looking ahead, there are some risks emerging regarding the inflationary outlook in the UK: Geopolitical tensions in Iraq and the Ukraine could push up energy prices in the future and bring physical inputs back to the drivers seat of SME cost inflation. Moreover, emerging skills shortages in some sectors of the economy could feed through to higher wage costs to SMEs. UK economy growing at its fastest annual rate since the financial crisis SME Monitor Q

8 Slight uptick in SME cost inflation in Q as improving labour market leads to higher wage costs Average SME annual cost inflation rate Source: ONS Cebr Analysis 5% 4% 3% 5% 1% 0% Costs for the UK s small and medium firms rose by 1.1% year-on-year in the first quarter of While this pace is faster than the 1.0% seen in the previous quarter and from 0.9% in the same quarter a year ago, the rate of inflation remains well below the highs of 2.4% seen in 2011 on average. This uptick in cost inflation was largely due to rises in employment costs: wage growth accelerated to 1.9% year-on-year this quarter, compared to 1.3% seen in Q4. This trend is likely to continue given recent improvements in the UK s labour market, which in turn will raise cost pressure for UK SMEs in terms of higher labour costs. -1% Q Q Q Q Q Q Q Q Q Q Q Q SMEs cost inflation also accelerated in terms of business services and construction inputs. This was partly offset by the fall in the price of physical inputs, financial services, and transport & storage services. Changes to the back history of this indicator reflect changes in ONS methodology See p16 for further details. SME Monitor Q

9 Employment costs continue to show the biggest increase while the cost of physical inputs and financial inputs falls Wage growth provided the greatest contribution to accelerating cost inflation for UK s small and medium businesses as the labour market continued on the recovery track. In fact, more than half of the 1.1% inflation rate can be attributed to wage inflation (0.6%). Cost pressures also rose for construction and business services. Together, employment, business services, and construction costs constitute over 50% of the total costs to UK SMEs on average. The acceleration seen in inflation of these products was partly offset by easing price pressures in other cost inputs. Some costs fell over the year in Q1, preventing a sharper uptick in inflation. In particular, the cost of physical inputs such as metals and chemicals fell by 0.8% year-on-year this quarter. This is the largest fall seen in the category since the final quarter of A slowdown in emerging markets is helping keep demand and hence prices of such commodities down. Financial services also decreased on an annual basis, falling by 3.3% year on year. Percentage point contribution to headline annual SME cost inflation rate Source: ONS Cebr Analysis 0.8% 0.7% 0.6% 0.5% 0.4% 0.3% 0.2% 0.1% 0% -0.1% -0.2% Q Physical Inputs Financial & professional * Transport & Storage Q Telecoms & IT Commercial rent Energy & utilities Other services Business Services Construction Employment costs * Includes financial services, insurance, accounting and legal services SME Monitor Q

10 Cost pressures for SMEs were highest for those in the construction and retail sectors in Q SME Monitor Q

11 Inflation accelerates for retail and construction, while price pressures for manufacturers and business services ease Cost pressures for SMEs were highest for those in the construction and retail sectors in Q1 2014, where annual inflation accelerated to 2.0% and 1.0% respectively. More than half of the rise in costs in the construction sector was accounted for by rising employment costs: these rose by 2.9% in the sector, compared to 1.9% for SMEs as a whole. SME annual inflation rate by selected industry Q Q Source: ONS Cebr Analysis 2% 1.5% SMEs in business services on the other hand saw cost pressures ease as inflation fell back to 0.3% from 0.5% in Q This was mainly due to the fall in employment costs in the sector, and was further supported by the fall in the costs of financial, insurance, legal & accounting services that support the sector. Finally, this quarter saw average cost inflation in the manufacturing sector ease to 0.2% compared to 0.7% Q This was largely due to a sharp decline in physical input prices for goods such as basic metals, which fell by 0.8%. This was despite a 0.6% pick-up in employment costs, as the decline in input prices for physical inputs such as basic metals was great enough to offset this and lead to overall easing of inflation in the sector. 1% 0.5% 0% Manufacturing Business Services The cost of physical inputs fell by 0.8%, the largest fall seen since 2001 Retail Construction Note that the chart here is of selected industries only and is not exhaustive of the entire SME economy. The overall SME inflation index presented on page 5 does, however, cover all SMEs. SME Monitor Q

12 Manufacturing sector costs back near deflation despite rising employment and energy costs Cost inflation in the manufacturing sector eased back to 0.2% year-on-year according to the latest data from Q This was despite rising employment and energy costs in the sector: annual wage growth among manufacturers accelerated to 2.9%, and energy costs rose by 2.9% yearon-year. Business services cost inflation also accelerated to 3.4% year-on-year in Q1. This was partly offset by falling costs of financial, insurance, legal & accounting services supporting the sector, where deflation stood at -6.7% year-on-year in Q1. Even more impactful was the reduction in the cost of physical inputs, which constitute more than half of the manufacturing sector s total costs. Basic metals prices fell by 4.3% year-on-year in Q1, while chemicals prices fell by 3.8% in the same period. SME annual inflation rate, manufacturers Source: ONS Cebr Analysis 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% Looking ahead, a slow-down in emerging markets, especially China, is expected to keep commodity prices down, sustaining the trend of easing cost pressures for UK SME manufacturers. -2% Cost inflation in the manufacturing sector eased back to 0.2% Q Q Q Q Q Q Q Q Q Note that the chart here is of selected industries only and is not exhaustive of the entire SME economy. The overall SME inflation index presented on page 5 does, however, cover all business types. SME Monitor Q

13 Construction sector cost inflation accelerates to highest rate seen in almost two years Costs for the UK s small and mediumsized construction firms rose by 2.0% year-on-year in the first quarter of This is a sharp uptick from 1.3% in the previous quarter, and the fastest pace at which costs have risen since Q The acceleration was chiefly driven by rising employment costs, which account for 42.4% of the sector s total costs. Wage growth accelerated to 2.9% year-on-year this quarter, compared to 1.0% in Q Cost growth for the sector s secondbiggest input, sub-contracted new construction, repair and maintenance, also accelerated marginally to 3.3% from 3.1% last quarter. This hike in prices was slightly contained by easing price pressures in terms of the sectors other inputs. For example, the cost of physical inputs actually fell by 1.6% over the year in Q1, making an overall negative contribution of -0.3% to the sector s SME inflation rate. SME annual inflation rate, construction firms 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% Q Q Q Q Q Source: ONS Cebr Analysis Note that the chart here is of selected industries only and is not exhaustive of the entire SME economy. The overall SME inflation index presented on page 5 does, however, cover all business types. Q Q Q Q SME Monitor Q

14 Retail sector enjoy reduced transport and storage services costs SME Monitor Q

15 Retail sector rising costs of business services raise pressure Cost pressures rose marginally for small and medium-sized enterprises in the UK retail sector, with annual cost inflation accelerating to 1.0% in Q This is slightly up from 0.8% seen in Q but still below the 1.2% seen in the first quarter of last year. A rise in the cost of business services supporting retailers by 3.0% year-onyear was the main movement causing the overall acceleration. Advertising and market research services in particular rose by 8.6% over the year in Q1. Business services constitute over a sixth of the sector s overall costs. On the other hand, the rise in costs was somewhat contained by a fall in the price of transport & storage services by 0.4%: warehousing costs in particular fell by 0.6% compared to the same quarter a year ago while road freight costs fell by 0.2% over the same period. Advertising and market research services rose by 8.6% SME annual inflation rate, retail firms 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% Q Q Q Q Q Source: ONS Cebr Analysis Note that the chart here is of selected industries only and is not exhaustive of the entire SME economy. The overall SME inflation index presented on page 5 does, however, cover all business types. Q Q Q Q SME Monitor Q

16 Business Services falling wages help bring down costs SME annual inflation rate, business service firms 6% 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% Q Q Q Q Q Source: ONS Cebr Analysis Note that the chart here is of selected industries only and is not exhaustive of the entire SME economy. The overall SME inflation index presented on page 5 does, however, cover all business types. Q Q Q Q Cost pressures eased for the UK s small and medium business service firms. Annual cost inflation eased back to 0.3% this quarter, down from 0.5% in Q This was mainly due to a 0.4% yearon-year reduction in wages, which constitute more than half of the sector s total costs. The cost of financial, insurance, legal & accounting services also fell by 2.8% as a whole over the year this quarter, further contributing to the downward movement in inflation. Finally, the growth in the cost of using other business services slightly accelerated to 2.4% this quarter. This is up from 2.0% in the previous quarter. It worked to offset the deflationary effect of wages and supporting services costs and lead to an overall positive inflation rate for costs faced by business services SMEs. The cost of legal & accounting services fell by 2.8% SME Monitor Q

17 2015 looks set to be more challenging as the Bank of England prepares to raise interest rates SME Monitor Q

18 SMEs continue to be more confident than larger businesses Business confidence among SMEs fell back marginally to in the latest quarter from in Q1, according to the ICAEW/Grant Thornton Business Confidence Monitor. This is still a significant improvement from just a year ago. Moreover, SMEs remain more confident compared to businesses with 250 or more employees. Confidence continued to strengthen among larger firms, albeit at a slower pace. The sub-indices now stand at an all time high of and for large and very large businesses respectively. This quarter s data build on positive quarterly increases in the past six months, highlighting the consistent nature of the UK s recovery. Business confidence is a leading indicator for growth, and the strength of recent data suggests that the UK economy will pick up further pace this year. Business confidence by company employment size SMEs (0-249) Q Q Q Q Q Source: ICAEW / Grant Thornton Business Confidence Monitor Large (250+) Very large (1,000+) Q Q Q Q Confidence scores are calculated by asking the question how confident are you in business prospects in next 12 months, versus last 12 months, with positive and negative answers being balanced to give overall score. Q Q Q Q Q Q Q Q Q SME Monitor Q

19 Credit conditions for SMEs remain broadly steady, but rate rise looms in horizon Pricing on lending to medium-sized SMEs was broadly unchanged in recent months: the median interest rate offered to medium-sized businesses stayed at 3.3%, in line with the 3.3% average seen over the previous twelve months. Borrowing costs became less favourable for smaller SMEs, both compared to their own levels in previous months, and to those faced by medium SMEs. According to the latest data from February, the median rate offered was 4.8%, up from 4.4% in November Median interest rates on variable-rate facilities for SMEs, three month average Smaller SMEs 5% 4% Medium SMEs Source: Bank of England. However, this is still below the 5.0% offered in the same month a year ago. Overall, credit conditions for all SMEs seem to have improved from the same time a year ago. However, the outlook for 2015 looks more challenging as the Bank of England prepares to raise interest rates in response to the UK s strong recovery. 3% Feb 10 May 10 Aug 10 Nov 10 Feb 11 May 11 Aug 11 Nov 11 Feb 12 Smaller SMEs are those with annual debit account turnover on the main business account of less than 1 million. Medium SMEs are those with annual debit account turnover on the main business account of between 1 million and 25 million. May 12 Aug 12 Nov 12 Feb 13 May 13 Aug 13 Nov 13 Feb 14 SME Monitor Q

20 Business failures rate slightly up this quarter but broader picture points to steady return to pre-crisis levels Just over 4,000 businesses were reported to have been liquidated in the first quarter of 2014 according to the latest data from the UK Insolvency Service. While this is slightly up from 3,800 failures in Q4 2013, it remains broadly in line with the average of 4,000 seen over the previous six months, and well below the high of 5,200 seen at the height of the crisis in Q However, there is still some way to go before business failures fall to their pre-crisis levels, when they averaged 3,300 between An improved business climate against the backdrop of a strong recovery is expected to bring down the number of insolvencies this year. Total number of UK company liquidations Source: UK Insolvency Service 6,000 5,000 4,000 3,000 2,000 1,000 However, from 2015 onwards monetary policy tightening is expected to put pressure on businesses access to credit, potentially leading to more insolvencies. 0 Q Q Q Q Q Q Q Q Q Q Q There is still some way to go before business failures fall to pre-crisis levels SME Monitor Q

21 Appendix: Employment costs and physical inputs make up the bulk of average SME costs Breakdown of business costs, % of total, by SME type Employment costs Construction Energy and Utilities Physical Inputs* Transport and Storage Other Service Business Services** Commercial Rent 100% 80% 60% 40% 20% Purchases of physical inputs and labour costs are the largest costs for SMEs, accounting for some 20% and 33% of total businesses expenses for the average SME. On top of this, a further 21% of total costs are spent on business services such as legal & accounting, advertising, IT & telecommunications. SMEs in manufacturing are heavily weighted toward physical inputs more than 50% of total cost is on these intermediate goods. SMEs in retail have a strong transport and storage weighting in their cost profile. Meanwhile, over half of the costs for business services SMEs are on employment. 0% Source: Cebr analysis All SMEs Manufacturing Construction Retail Business Services *including raw materials such as those from agriculture, mining and forestry, as well as manufactured products such as steel, textiles, timber, chemicals and foodstuffs. ** including finance, legal & accounting, IT & telecoms SME Monitor Q

22 Contact For any questions or comments on this report please contact: Andy Homer, Corporate Affairs aldermore.co.uk Methodological note: The figures presented within this report are calculated from a range of data provided by the Office for National Statistics (ONS), including the Services Producer Price Indices (SPPI). In February 2014 the ONS updated the methodology of these series, rebasing from 2005 to 2010 to reflect changes in patterns of input use by firms and new products which have come to market in recent years. This update has changed historical SPPI data, and has resulted in some small changes to the back history of the Aldermore SME cost inflation indices. Any differences between figures reported in this and past reports is due to these changes in official data, and reflects the best information available to the authors at the time of publication. SME Monitor Q

23 SME Monitor Q aldermore.co.uk