Business Barometer Falls On Greek Exit Fears

• UK business perceptions of economic prospects in May fel l sharply, as uncertainty and fears surrounding the consequences of a potential Greek exit from the euro escalate.
• The sharp decline means that the improvements in confidence during Q1 have been reversed, but sentiment remains above levels at the end of 2011 and during the height of the 2008/9  financial crisis.
• Our model, which takes into account recent survey results, points to ‘underlying’ quarterly GDP growth (excluding the Diamond Jubilee effect) of 0.2% in Q2, which would be a weak outturn but nevertheless better than the previous two quarters.
• However, unless business sentiment improves in the coming months, aided by a better euro area economic outlook, we could see a renewed weakening of growth prospects in Q3.

A BETTER ‘UNDERLYING’ Q2, BUT POTENTIALLY WEAKER ‘UNDERLYING’ Q3

The more forward-looking, but also more volatile, component of the Business Barometer plunged in May, as businesses’ fears about the consequences of a potential Greek exit from the euro escalated. The net balance for economic prospects dropped 47 points to -21%, a record one-month decline, though it remains just above levels at the end of 2011. It is still well above the lows experienced during the 2008/9 financial crisis. Only 22% of companies in the latest survey said that economic prospects had improved, the weakest level for nearly three-anda-
half years, while 43% said that they had worsened, though this was less bleak than last December (53%). The survey’s other main question about own business prospects also fell, with the net balance declining 8 points to 35%, the lowest level since January.

Taking the net balances from both main questions together, our normalised Business Barometer index (BBI) is at the lowest level this year, see chart 2, but is still higher than the November and December 2011 surveys which presaged the negative quarterly outturn for Q1 2012 GDP. Plugging in the latest monthly survey results, our model suggests ‘underlying’ quarterly GDP will rise 0.2% in Q2, which would be a weak outturn but nevertheless better than the previous two quarters. The headline Q2 GDP figure, however, will be affected by a negative statistical effect from the Diamond Jubilee extra bank holiday which estimates suggest could reduce quarterly growth by around 0.5 percentage points in Q2, but add a similar amount in Q3. Policymakers are likely to ‘look through’ this temporary effect and focus on trends in the underlying growth rate.

Although our model points to an improvement in underlying economic growth for Q2 as a whole compared with the previous two quarters, driven by stronger sentiment between February and April, we could see a renewed weakening of ‘underlying’ growth prospects in Q3 (excluding the ‘payback’ from the Q2 bank holiday effect) if business sentiment remains at or deteriorates from current levels, particularly if the euro crisis remains intense. On the other hand, some easing of euro area concerns would help to reverse some of the latest fall in business sentiment.

BROAD-BASED DECLINES IN SECTORS AND REGIONS, BUT MARGINS IMPROVED

Since June 2011, we have also asked companies about their staff levels, profit margins and domestic prices. The net balance for expected staff levels in the coming year fell slightly by 2 points to 21%, but remains significantly higher than the low of 9% last December. The net balance for profit margins compared with three months ago rose 2 points to -15% in May and, while negative, is higher than the low of -35% last October. The improvement in margins comes despite a fall of 6 points to 7% in the net balance for average domestic prices versus three months ago, suggesting that lower costs have supported margins.

For the regional and sector summaries, we have calculated a ‘composite index’ which equally weights the net balances for economic prospects, own business prospects, staff levels and profit margins. Charts C and D show broad-based declines in the composite index across sectors and regions in May, most notably in the North and Midlands and in the retail & distribution sector.

Note: This month’s Lloyds Bank Business Barometer was conducted during 8-18 May 2012. The sample size was 301 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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