Spend Matters welcomes this guest post from by Ben Orhan, senior economist with IHS Pricing and Purchasing.
The U.K. manufacturing sector is enjoying a considerable renaissance following sterling's slump over the last few months. A fall of around 15% against the euro since June has aided U.K. manufacturers considerably, with British imports suddenly offered at a relative discount for foreign buyers. This has been especially advantageous for British firms at a time when domestic margins are the lowest in six years, as indicated by the difference between the IHS Output Prices Index versus the Input Prices Index. Indeed, the October 2016 input PPI saw annual inflation of 12.2%, a multi-year high. In contrast, the output PPI inflation was just 2.1%, a considerable gap and one that will squeeze producer margins even tighter.
The U.K. IHS Markit Manufacturing PMI data has shown consistent growth since sterling began to weaken in the aftermath of the June 2016 Brexit vote. Indeed, following a slump in July as business confidence shattered in the immediate aftermath, the manufacturing PMI has surged. Buoyed by heightened export demand for more competitively-priced British goods, manufacturers are enjoying the strongest period of growth since early 2014.
However, with British producers heavily exposed to dollar-denominated input costs, there are signs that this sweet spot may not last. The October U.K. PMI results categorically highlight this, as inflationary pressures begin to build. The IHS Markit U.K. PMI Input Costs Index, which assesses prices across the total economy, showed the largest monthly increase in 20 years of data collection, rising to its highest since March 2011. This significant gain was largely due to a surge in the number of firms reporting higher prices resulting from the weakened exchange rate. As input costs rise, the current enhanced level of British export competitiveness is unlikely to last, especially if rising costs stoke higher consumer price inflation, which then feeds through to increased wages.
Higher input costs, coupled with higher wages, will erode the temporary boost U.K. manufacturers have secured from a weaker pound. The magnitude of this slide in competitiveness depends on numerous factors, none more so than the scale of wage rises. Therefore, this latest Markit PMI release signals the end of a low inflationary environment and, consequently, the end of the depreciation-induced competitiveness gains for U.K. manufacturers. Note that the export orders index from the PMI survey signaled a modest easing of growth in October.
Of course, these cost increases will only affect manufacturing gradually, and those companies with a solid understanding of supplier costs can seek to delay and mitigate these increases for longer. Indeed, we expect U.K. export volumes to continue to climb strongly for a third successive month, signaling that the start of sharp input cost increases has yet to filter into lower export demand. However, the period of exceptionally strong U.K. manufacturing and export growth appears set to wane, as input cost increases across the board feed back into higher selling prices and offset the competitive gain from the weaker pound.