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
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 UKâ€™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 poundâ€™s trade weighted exchange
rate stays weak, and UK economic growth
remains well below that of its key export partners, the UKâ€™s trade deficit could
turn from its current account deficit of Â£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.
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 â€˜importantâ€™ 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 Fridayâ€™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%.
ô€‚„ 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 Bankâ€™s Â£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.
ô€‚„ 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.
ô€‚„ All eyes will be on Fridayâ€™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 Fridayâ€™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 weekâ€™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%.
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