Summary of Business ConditionsAugust 2010

Agents’ summary of business conditions

• The Agents reported that business confidence across a wide range of industries had ebbed in recent months. Many contacts attributed the fall in confidence to the announcements made in the June Budget, although few contacts had changed their plans for output, investment or employment as a result.
• Consumer spending growth had softened over the past few months, reflecting weaker retail sales growth.
• The number of housing market transactions had also eased back.
• Investment intentions remained consistent with a gradual, rather than robust, rise in spending.
• Exports had picked up further, driven by a pickup in world demand.
• Services turnover had edged higher, although volume growth in the professional and financial sector was likely stronger than growth in turnover, reflecting lower prices and fees than a year earlier.
• Manufacturing output growth had been robust through Q2, reflecting stronger export growth and, to a lesser extent, increases in output for the domestic market.
• Construction activity remained subdued. Despite a rise in repair and maintenance, commercial construction activity remained weak, and some public sector projects had been postponed or cancelled.
• Private sector employment intentions had risen modestly in recent months. But contacts expected offsetting cuts in public sector headcount over the next year or so.
• Pay growth remained muted, albeit a little stronger than at the start of 2010. Many non-labour input costs had risen further.
• Contacts reported that imported goods price inflation had edged up, due to higher inflation and some emerging capacity constraints in the Far East.
• Annual consumer price inflation remained elevated in July, as weaker goods price inflation was offset by a modest rise in services price inflation.
• It remained too early to assess definitively the impact of the announced rise in VAT. But initial findings suggested that, on balance, contacts expected to pass through much of the rise early in January 2011.

Demand

Business confidence
The Agents reported that business confidence, which had beenbuilding slowly through Q1, appeared to have ebbed in recentmonths. The fall in confidence was widely spread acrosscontacts and industries. Many businesses linked the decline inconfidence to the planned cuts in public spending, which wereexpected to lead to weaker demand, both directly in thosesectors with significant public sector exposure, and indirectlyby reducing public sector employment and hence householdincome.

Nonetheless, few contacts had, as yet, changed their plans foroutput, investment or employment in response to theannouncements in the Budget. That reflected widespreaduncertainty about the impact of the fiscal consolidation, withmany contacts now waiting for the October Spending Review,which was expected to provide greater detail about the publicspending cuts.

Consumption
The Agents reported that the underlying pace of retail salesvalues growth had softened over the past couple of months(Chart 1). Growth in volumes is likely to have been slowerthan growth in turnover, given elevated rates of retail goodsprice inflation.

By contrast consumer services turnover had, on balance, edgedhigher through Q2 and into July (Chart 1). Domestic tourismcontacts in particular reported strong demand, with moreresidents choosing to holiday in the United Kingdom in recentmonths. Nonetheless, trading conditions remained tough formany contacts in a wider range of consumer servicesindustries, as consumers remained focused on value andunusually sensitive to pricing points.

Looking ahead, a number of contacts expected the rise in VATin January 2011 to bring forward some expenditure into Q4,particularly on large ticket items. Nonetheless, the majority ofcontacts continued to express concerns about spendinggrowth over the rest of the year, reflecting expected cuts inpublic sector employment and the associated squeeze onhouseholds’ disposable income.

Housing market
The supply of properties coming to market had risen since thesuspension of Home Information Packs in England and Wales.But demand continued to be restrained by the availability ofmortgage finance and, according to some contacts, byconsumers’ concerns about future job security. On balance,the Agents judged that the number of housing markettransactions had fallen back over the past three months.

Business investment
Investment intentions had continued to edge up gradually,although the Agents reported that businesses’ plans remainedconsistent with a gentle, rather than robust, rise in investmentspending. The majority of investment plans remained focusedon asset replacement and maintenance (in particular car fleetsand IT projects). A small number of exporters had planned toincrease investment spending.

Exports
Export growth had continued to pick up in July. Many contactsascribed the improvement in sales to stronger global growth,particularly in the Far East, the Middle East and Russia. Bycontrast, sales to the euro area had remained subdued.

The exchange rate appeared to have played only a limited rolein the rise in exports to date, with most exporters using thelower level of sterling to boost their margins. But in July therehad been a number of reports of businesses cutting theirforeign currency prices and targeting market share. The small,more recent appreciation of sterling had not, as yet, had muchimpact on exporters’ expectations.

Output

Business services
The level of services turnover had edged higher in July,although four-quarter growth remained below trend (Chart 2).Demand growth remained strongest for legal and accountancyservices, where growth in volumes was likely to have beenstronger than growth in turnover, due to falls in many chargesand fees over the past year. But contacts had become a littlemore pessimistic about the outlook for Q3 and beyond —those businesses with exposure to the public sector, includingconsultancies and advertising firms, had expressed particularconcerns about falls in future revenues.

Turnover growth in the other business services sector hadremained patchy. For example, transport, haulage anddistribution activity had picked up, but demand for events andconferences remained little changed at subdued levels.Overall, the Agents judged that turnover was only marginallyhigher than a year earlier (Chart 2).

Manufacturing
Growth in manufacturing output continued to pick up,primarily reflecting stronger export growth. But outputdestined for the domestic market had also increased, in partreflecting increased demand from businesses who hadpreviously sourced their goods from abroad. Output in thefood and drink sector and in the automotive supply chain hadboth picked up. But activity remained extremely weak amongthose businesses supplying the construction sector.

Construction
Output in the construction sector remained significantlyweaker than in the other sectors of the economy. Althoughrepair and maintenance work had picked up in July, the pace ofnew residential home building had softened a little, andcommercial construction activity remained weak.

Moreover, the impetus from public sector work, which hadbeen considerable during the past two years, had begun tofade, with some projects being postponed or cancelled. Mostcontacts expected a further fall in public sector demand overthe next year or so.

Credit conditions

Credit conditions had improved a little since the start of theyear, although smaller businesses and those in certain sectors(such as the property sector) had benefited much less thantheir larger counterparts or those in other sectors. Demand forbank finance had remained weak and companies continued topay down debt. The availability of trade credit insurance hadimproved in recent months, but demand remained subdued, asmany businesses had adapted to the lower availability of coverfollowing the marked tightening in conditions at the start ofthe financial crisis. Bad debts remained well contained.

Employment

In recent months, private sector contacts had reported only amodest rise in recruitment intentions, with uncertainty aboutthe economic recovery prompting many contacts to meetincreases in demand using their existing resources, or by hiringtemporary staff. Moreover, the modest rise in private sectorintentions had been outweighed by expected cuts in the publicsector. A few contacts also noted that cuts in public spendingmight lead to further falls in private sector employment, byreducing demand for private sector services.

Capacity utilisation

On the whole, contacts reported that they had sufficientcapacity to meet future increases in demand using theirexisting resources. The margin of spare capacity, however,had been shrinking following incremental increases indemand over the past year. For example, in some pockets ofthe manufacturing sector, contacts reported that the marginof spare capacity (particularly in labour) had been largelyeliminated. Some contacts had also encountered strains in afew global supply chains (including automotive and electronicscomponents). That, together with reports of limitedavailability of shipping containers, had led to lengthening leadtimes for certain components.

Costs and prices

Labour costs
Overall, growth in basic pay remained muted. But, since thestart of 2010, pay freezes had become less common andaverage settlements had drifted a little higher. These smallincreases in basic pay were usually aimed at aiding staffretention, rewarding better trading performances and boostingmorale among those who had accepted pay freezes over thepast year or two. To date, the impact of elevated rates ofconsumer price inflation on pay negotiations had been limited.But a growing number of contacts expressed concerns aboutfuture pay rounds, especially were inflation not to fall back.

Pay drift (which captures changes in earnings related toworking patterns) and bonuses had also picked up during theyear. Those increases had reflected the restoration of hoursand (in some cases) overtime, as well as increasedcommissions and bonus payments, which some contacts hadused as an alternative to awarding increases in basic pay.

Non-labour costs
The Agents reported that materials cost inflation hadcontinued to rise further, although the pace of increaseappeared to have slowed since 2010 Q1. Metals (primarilysteel) and cotton prices had continued to rise, as had the costof paper, cardboard, packaging and transport containers.

Contacts also reported that imported goods price inflation hadedged higher in July, reflecting the lagged effects of the lowerlevel of sterling (the recent appreciation notwithstanding) aswell as higher cost pressures and emerging capacityconstraints in some economies, particularly in the Far East.

That said, not all input costs had increased in recent months.For example, the prices of some oil derivatives such as plasticsappeared to have reached their peaks, and utility costs hadcontinued to decline for many businesses that hadrenegotiated their expiring contracts. A number of businesseshad also benefited from lower commercial rents, or longerrent-free periods.

Output prices
Overall, contacts continued to report little pricing power.Businesses operating in the manufacturing sector hadsucceeded in raising output prices a little in recent months(Chart 3), passing on some (but not all) of the increases in fueland raw materials costs to their customers. In the servicessector, downwards pressure on prices and fees had persisted,reflecting strong competition and proactive negotiation byclients. On balance, the Agents judged that business servicesprices remained below their levels a year earlier (Chart 3). Inthe construction sector, the Agents continued to hear reportsof businesses tendering for work at, or even below, cost.

Consumer prices
Overall, annual CPI inflation remained elevated, driven by thereintroduction of the standard rate of VAT in January 2010 andincreases in import price inflation over the past year. In July,contacts reported a further, gradual increase in retail servicesprice inflation (Chart 4). Residential rents had been pickingup, and leisure services providers had also been increasingprices in recent months.

By contrast, annual retail goods price inflation appeared tohave eased back in July (Chart 4). Food price inflation haddeclined over the past few months, and some contactsreported falls in fuel prices, following strong increases earlier inthe year.

Looking ahead, it remained too early to draw definitiveconclusions about the extent to which contacts planned topass on the rise in VAT. Based on the Agents’ discussions so far,contacts expected to pass through much of the rise early inJanuary 2011. But for many, the decision would ultimatelydepend on how the economy evolved over the rest of the year,and on the importance of pricing points, which would limitsome contacts’ ability to raise prices.