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Monday February 2, 2009 - 11:42:02 GMT
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Economics Weekly - How bleak is the future for UK manufacturing? Weekly economic data preview - Focus on BoE/ECB rate decisions and US employment report

Economics Weekly - 2 February 2009


How bleak is the future for UK manufacturing?

 

With the volume of world trade dropping fast and global growth measured at market exchange rates

set to contract by about 1%, its worst performance since the 1945, it is no surprise that global industrial production is falling sharply. The countries most affected by this fall in world trade growth, and therefore seeing the biggest falls in industrial production, are not surprisingly those economies

most exposed to international trade. This includes the UK, where industrial production in the year to

November was down by 7% and is likely to have fallen by an annual 8% in December when those

figures are released later this week. Other countries are even worse off, but we concentrate on the UK in this briefing.

 

A global downturn is hitting industrial production in most countries...

IMF figures show that world trade and industrial production are falling very sharply, see chart a. This suggests quite a bleak future for UK manufacturing output, with a weaker exchange rate unlikely to help boost exports at a time when global export volumes are declining so sharply. And this at a point when the global financial crisis is likely to set back output growth in the UK services sector more severely than in many other countries. The reason is that UK firms have been at the forefront of global trade in the financial instruments most affected by the current financial crisis, and so, coupled with the deregulation, the UK’s services sector has grown much faster than its manufacturing sector, especially since 1994, see chart b.This suggests that, if growth in services is significantly slower as expected, then the strong likelihood is that UK overall economic growth will also be well below the average of the last decade, when annual average growth in real (inflation-adjusted) terms was 2.9%. The chart suggests that the vast majority of the growth in the UK economy for well over a decade has come from the services sector. And it is unlikely that this could be replaced by any other industry any time soon.

 

...but UK manufacturing exports are up on the year as a weaker exchange rate and slower economic growth than elsewhere helps the manufacturing sector...

Despite the slower growth in the world economy, however chart c shows that UK export growth of manufactured goods has risen compared with year ago levels. Now, this is likely to be unsustainable with world trade volumes falling sharply, but it does suggest that the prospects for the sector are not universally bleak. Chart d shows that the fall in the exchange rate has been very pronounced, and this should mitigate imports as well as help exports. What are the chances that UK manufacturing output gives a positive surprise in the years ahead? In terms of UK exports, the share of manufacturing out of the total has been falling, even though generally the value of these exports has risen pretty consistently, see chart e.

 

The reason why manufacturing goods share of total UK exports has fallen is because services exports have risen even faster, driven by the boom in global financial services in the past decade. It is also interesting to note that the manufacturing sector is more competitive in terms of productivity than many suppose, see chart f, with growth in productivity faster than in the services sector (though this is partly due to falling employment levels in manufacturing). However, our calculations suggest that if the pound’s trade weighted exchange rate stays weak, and UK economic growth remains well below that of its key export partners, the UK’s trade deficit could turn from its current account deficit of £26.6bn last year, into a small surplus by 2011/2012, see chart g. This outcome also assumes that wage inflation stays low, so the UK sees all of the benefits of the fall in the exchange rate in an improvement in its relative unit labour costs compared with other countries. The scenario of a current account surplus and a sharp rise in manufacturing output and exports is also dependent on a strong recovery in global trade growth.

 

...and so the prospects for UK manufacturing firms are not universally bleak

These are big ifs, but suggest that the possibility exists for the fall in the exchange rate to help rebalance the UK economy in the years the come, away from its decade long dependence on services and consumer spending towards manufacturing and investment. The end result will still be weaker UK economic growth on average in the years ahead than in the last decade - we estimate that annual trend growth will be 2 to 2.25%, so well below the 2.9% per year recorded in the last 10 years. However, to write off UK manufacturing because of the very poor short terms prospects for output is to possibly misread the likely good performance of some sectors within it in the years to come.

Trevor Williams, Chief Economist, Corporate Markets

 

 

Weekly economic data preview - 2 February 2009

 

Focus on BoE/ECB rate decisions and US employment report

 

The main focus this week will be on the interest rate decisions by the Bank of England and the ECB on Thursday and the US employment report on Friday. The BoE is expected to cut interest rates by 50bps to another all-time low of 1%, with the manufacturing and services PMI surveys earlier in the week likely to confirm continuing severe contraction in the economy. In contrast, the ECB has signalled that the next ‘important’ meeting will be in March, hence it is widely expected to leave rates at 2% this week, but a cut would not be a complete shock. The ECB press conference following the rate announcement will therefore be closely scrutinised for clues about the March meeting. The euro zone PMI surveys and German factory orders/industrial output will confirm the rapid weakening of economic activity. In the US, the ISM and ADP employment surveys will provide early hints of Friday’s official employment report, which is expected to show another fall of around 550,000 jobs in January and a rise in the unemployment rate to 7.3% from 7.2%, the highest since 1993. Elsewhere, the RBA is forecast to reduce interest rates by 100bps to 3.25% and Norges Bank is expected to cut rates by 50bps to 2.5%.

 

􀂄 The deteriorating economic outlook and prospects of inflation falling into negative territory in the coming months will prompt the Bank of England to reduce interest rates again on Thursday. The MPC is expected to cut rates by 50bps to an all-time low of 1%. Further details of the Bank’s £50bn asset purchase facility, specifically the mechanisms through which initial asset purchases will be conducted, will be announced this week. The manufacturing and services PMI surveys will be released earlier in the week and are expected to show monthly levels consistent with a sharp contraction in overall economic output. December industrial production and January producer prices are due on Friday, the latter expected to confirm easing price pressures.

 

􀂄 The euro zone manufacturing and services PMI surveys are expected to confirm that economic activity continued to contract at a significant pace in January. The preliminary releases showed a small monthly rise in the composite PMI survey to 38.5 from 38.2, but this remained well below the 50 level separating growth and recession. Euro zone retail sales on Wednesday are forecast to show a third consecutive monthly fall in December, as consumer confidence declines and unemployment rises. German industrial production figures are expected to confirm a sharp fall-off in economic activity in the final quarter of 2008, with output down around 9% in the year to December. Last week also saw an unexpectedly large fall in euro zone flash CPI to 1.1% in January, the lowest since July 1999. The data backdrop suggest that ECB President Trichet is likely to signal lower interest rates for the March meeting. However, the ECB has indicated that it is likely to leave rates on hold this week, having reduced them by 50bps to 2% only on January 15th, but a cut would not be a complete shock.

 

􀂄 All eyes will be on Friday’s US employment report, which is expected to show a continuation of the accelerated pace of job cuts since last September. Another 550,000 jobs may have been lost in January and the unemployment rate is forecast to climb to 7.3%, the highest since January 2003, and is likely to surpass the early 1990s peak of 7.8% in the coming months. Earlier in the week, the ISM surveys and ADP employment report will provide hints on the outcome of Friday’s non-farm payrolls. The manufacturing ISM is expected to remain weak at around 33, while the non-manufacturing ISM is forecast to fall to 39 from 40.1. Early indications suggest that the economy may contract by an even faster pace in the current quarter than the 3.8% annualised fall in Q4. Elsewhere, on the heels of last week’s unexpectedly large 150bps rate cut to 3.5% by the RBNZ, the RBA on Tuesday is predicted to reduce rates by a further 100bps to 3.25%, as economic prospects deteriorate and inflation falls. Norway and South Africa are also expected to reduce rates by 50bps and 100bps, respectively, to 2.5% and 10.5%.

Hann-Ju Ho, Senior Economist

 

 

Economic Research,
Lloyds TSB Corporate
Markets,
10 Gresham Street,
London EC2V 7AE
,
Switchboard:
0207 626 - 1500
www.lloydstsb.com/corporatemarkets

 

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