UK industry is on a roll – but inflation could send it on the slide

https://www.theguardian.com/business/2017/feb/01/uk-industry-inflation-manufacturing-costs

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It’s looking good for Britain’s long-suffering manufacturers. Order books are strong, the global economy is picking up and the weakness of the pound is making exports more competitive. Industry is on a roll.

Well, maybe. Nobody likes to be a party pooper but we’ve been here before. Many times before, in fact. Over the past four decades there have been periods – sometimes quite lengthy periods – when it has looked as if a new dawn is breaking for manufacturing. Yet the promised renaissance has never happened.

There is no question that the latest Cips/Markit survey is strong. Rising domestic demand is prompting firms to increase output. On the basis of the findings manufacturing output could rise by 2% in the first quarter. If so, it would add about 0.2 percentage points to quarterly growth and suggest some much-needed rebalancing of the economy from consumption to production and from services to manufacturing.

But it is not all good news. Given the fall in the value of the pound since the Brexit vote in June it was disappointing to find that so little of the new business reported by industry came from sales overseas. Export orders were less buoyant than in recent months, even though most of the world’s big markets – the US, China and the eurozone – have been showing signs of perking up.

Perhaps even more worrying are the signs that manufacturers are starting to pass on increases in fuel and raw material costs to their customers. The past six months have brought an end to the disinflationary period that began with the sharp fall in oil and other commodity prices in 2014.

Firms have been hit by a double whammy: rising oil prices and a depreciation of the pound. Prudently-run companies will have hedged against changes in market conditions, but these hedges don’t last for ever. Many have now expired, forcing companies to either absorb the higher input costs or pass them on.

If firms pass on the costs, prices in the shops will rise and that will choke off the increase in domestic demand that has been behind manufacturing’s decent performance in recent months. What’s more, exporters will fritter away the competitive benefits of a cheaper pound.

All of which is to say that the outlook for manufacturing is not quite as rosy as it looks. Enjoy it while it lasts.