Business Barometer reaffirms underlying weakness

• Economic prospects improved for a second straight month in July, but have yet to reverse the large decline in May, while own business prospects fell to a 7-month low. Overall sentiment remains weak.  
• The survey results point to a weakening of underlying economic activity in the third quarter, though official growth data may eventually show a more robust outturn due to statistical distortions related to the extra bank holiday in Q2.  
• Hiring intentions fell to the weakest level this year, while domestic prices and profit margins were unchanged on the month, though they are still trending lower.  
• Sentiment was particularly weak in manufacturing and also fell in retail and in the North and the Midlands, while it rose marginally for other services and in the South.  

ECONOMIC PROSPECTS IMPROVE, BUT OVERALL SENTIMENT IS WEAKER  

UK business sentiment regarding economic prospects improved for a second straight month in July, but these modest rises should be seen in the context of the very large fall in May. As such, the net balance for economic prospects, which rose 4 points to -8%, remains relatively weak by historical standards. Companies’ sentiment regarding their own prospects, moreover, fell in July to a 7-month low of 30%, as weak economic prospects filter down to perceptions about their own business outlook.

We normalise and average both these balances to derive our Business Barometer Index (BBI) which declined to -0.79 in July from -0.69 in June. The BBI is a leading indicator of economic activity and anticipated the double-dip recession, as sentiment weakened prior to and around the turn of the year. The latest results from our survey suggest that underlying economic activity is set to weaken in the third quarter, after showing some signs of improvement in Q2 (chart A). This may not, however, be reflected in official GDP growth statistics which are distorted by the effects of the extra bank holiday for the Diamond Jubilee, which artifically depressed Q2 growth, with the likelihood of a similar temporary uplift in the headline official growth numbers in Q3. Policymakers, however, will focus on the underlying picture which the Business Barometer suggests will worsen in the third quarter, despite some additional positive impact from the Olympic Games.

Inputting the Business Barometer Index into a probit model to gauge the probability of recession suggests that the start of the 2008/9 recession was correctly anticipated, as was the latest economic downturn in late 2011 and early 2012 (chart B). The model indicates that the probability of recession subsided in March and April, but spiked higher in May as the euro crisis intensified again. It has since hovered around the 50% level, suggesting economic weakness is set to remain.

MANUFACTURING CONFIDENCE FALLS SHARPLY  

The other parts of the survey show that hiring trends weakened in July. The net balance for staff levels rose sharply in June to 30%, but subsequently fell to a 7-month low of 10%. The decline was broad-based across regions and sectors, but was particularly severe in manufacturing (down 40 points to -2%), likely related to weaker demand from Europe and indications of broader global slowdown. The overall net balances for average domestic prices and profit margins were unchanged in July at 5% and -19%, respectively, but they have both trended lower in recent months. Price trends have weakened particularly in the manufacturing and retail sectors, but have held up better in other services.

A more comprehensive assessment of the sectoral and regional picture is provided by calculating a composite net balance which equally weights the results for economic prospects, own business prospects, staff levels and profit margins. The composite net balance for manufacturing fell to a nine-month low of -3% in July and has also declined in retail over the latest month (down 5 points to 3%). For other services, it rose 2 points to 8%, but even in this sector the recent trend remains downward. Regionally, the composite net balance in July fell in the North and Midlands and rose slightly in the South. The recent trend has been downward in all the three regions, though to a lesser degree in the South.

Note: This month’s Lloyds Bank Business Barometer was conducted during 2-12 July 2012. The sample size was 305 companies with turnover above £1 million from all sectors and regions. Responses are re-weighted to reflect the composition of the economy.

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