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Debt crisis dampens hope despite rise in manufacturing

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Stronger manufacturing numbers last week raised hope that the British economy has escaped recession at the start of the new year. However the uncertainty surrounding the eurozone debt crisis still makes a contraction a real risk for the country.

The manufacturing purchasing managers’ index (PMI), a keenly-watched indicator compiled by the financial information provider Markit and the Chartered Institute of Purchasing & Supply (Cips), hit an eight-month high in January, fuelled by a jump in output, rising orders and a fall in input costs.

The manufacturing PMI rose to 52.1 points last month, up from the 49.7 recorded in December. A reading above 50 suggests that activity increased during the month while anything below implies contraction.

Ian Kernohan, an economist at Royal London Asset Management, says last week’s PMIs suggest Britain could avoid recession during the opening three months of the year.

According to a preliminary estimate by the Office for National Statistics (ONS), the British economy contracted by 0.2% in the final quarter of the year. Several commentators expect the reading for 2012’s first quarter to show a similar fall. (News analysis continues below)

 

However, Kernohan argues the manufacturing and services PMIs tend to be a better guide to the underlying economic situation than the ONS’s early GDP data, which is often subject to revision.

“Generally in a recession you see quite a sharp downward movement in PMIs, certainly in the last recession, and that just hasn’t happened this time,” he says.

“We had a bit of a dip in the manufacturing sector in November and December but that bounced back rapidly in January.”

The economist highlights the improvement in the manufacturing output balance, which moved from about 50 points to close to 56. The survey shows manufacturing output expanded at its fastest pace since March last year and represents a “vast improvement” on the 0.9% decline seen at the end of 2011.

 

 

Kernohan also points out that the service sector, which represents the bulk of Britain’s GDP, has not seen significant falls in activity. Markit’s services PMI remained above 50 throughout 2011.

“Taking those two numbers together, I’d say it’s doubtful the economy contracted in either quarter four of 2011 or the first quarter of 2012,” he adds.

Andrew Goodwin, a senior economist at Oxford Economics, is cautious about reading too much into the manufacturing PMI, no matter how encouraging the recent improvement may be.

“This is one month’s figures that follow on the back of a pretty bad trot,” he says. “When you look at where we were this time last year, we’re still quite a long way short of the kind of balances we had back then.”

”If the global economy is picking up, then our companies are going to benefit from that”

Goodwin predicts Britain will experience a “fairly mild” recession over the last quarter of 2011 and the first of 2012. This will “feel very different” from the recession of 2008/09 and recovery is likely to be seen in the second half of the year, he adds.

However, Kernohan argues that Britain’s “small, very open” economy will allow the manufacturing sector to benefit from signs of improvement on the global stage.

Manufacturers witnessed a moderate improvement in orders from America, Brazil, China and the Middle East during January. Meanwhile, the eurozone’s PMI shows its manufacturing contraction eased last month, driven by the return to growth in Austria and Germany.

“We’re very sensitive to what happens in the global economy,” Kernohan says. “If the global economy is picking up, then our companies are going to benefit from that.”

Goodwin, on the other hand, points out that most manufacturing exports head to the eurozone, which is expected to be in recession throughout the opening months of 2012.

 

 

The exports going to Germany are roughly double the combined total destined for the so-called Bric markets of Brazil, Russia, India and China, the economist claims, which make British manufacturing “heavily tied” to the situation on the continent.

“If that uncertainty of what’s happening in the eurozone doesn’t clear, then a state of almost paralysis in the economy – where people don’t want to commit to orders and the like – will continue,” he warns.

British manufacturing is attempting to boost exports to emerging markets to reduce its reliance on Europe. But Goodwin says this is a long-term plan that does not greatly help the country take advantage of short-term improvements in these markets.

The economist concedes that the British service sector has been “a little bit more robust” than manufacturing, mainly because it relies less on exports. However, the sector suffers from similar problems, such as weak investment and recruitment activity.

Manufacturers themselves are cautious in their outlook for the coming quarter. The latest CBI Industrial Trends Survey shows manufacturing companies predict domestic orders will level out over the next three months, while only slight rises in crucial export orders are expected.

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