Business Barometer continues to improve

• Economic prospects improved for a third straight month in August, with the net balance moving into positive territory for the first time since May. Business prospects also improved this month moving back to the modest levels seen during Q1.  
• Our models show underlying activity should improve towards the end of the year and that the risk of recession has eased as both sentiment measures improved this month. However the strength of the potential recovery remains fragile due to the historically low level of the Business Barometer components. 
• Our previous survey results still suggest a weak outturn for underlying economic activity in Q3 GDP, released on October 25. A more positive outturn is likely due to the impact of the extra bank holiday and the potential for any positive Olympic effects.  
• Composite sentiment has improved across all regions and sectors this month, most impressively in the manufacturing sector and regionally in the Midlands.  

BUSINESS SENTIMENT PUSHES HIGHER FOR LONGER POST-OLYMPICS 
 

UK business sentiment regarding economic prospects improved for a third straight month in August following Team GB’s successes at the Olympic Games. However these modest rises should remain in the context of the very large fall recorded in May. The net balance for economic prospects, which rose 18 points to 10%, is still at a low level by historical standards and suggests continued lacklustre underlying activity into the end of the year. Chart A shows that the economic prospects index leads quarter-on-quarter GDP growth by 4 to 5 months. Therefore the recent improvement in sentiment is only likely to feed through to GDP towards the end of the year and early 2013, if these gains are sustained. Companies’ sentiment regarding their own prospects also rose this month moving up 10 points to 40%, however the current trend is flat and the balance is below its long term average, a reason that any potential recovery in underlying activity this year is likely to be fragile and shallow.

Recent results from our survey suggest that underlying economic activity is still set to weaken in the third quarter, after showing some signs of improvement in Q2. This may not be reflected in official GDP growth statistics released on October 25, which will be distorted by the effects of the extra bank holiday for the Diamond Jubilee, which depressed Q2 growth, with the likelihood of a similar temporary uplift in the Q3 growth numbers. However policymakers are likely to focus on the trend of underlying activity, which the Business Barometer suggests will worsen in the third quarter before potentially improving again in Q4, leaving growth almost flat for 2012 overall.

Our Business Barometer Index (BBI), the normalised average of both economic and business prospects, improved to -0.12 in August from -0.79 last month. The BBI is a leading indicator of economic activity and anticipated the double-dip recession. 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 has eased after remaining elevated in recent months with the uncertainties in Europe and the wider global economy.

 MANUFACTURING SENTIMENT IMPROVES TO TAKE GOLD 
 

In the detail of the survey there was an increase in sentiment across all sectors this month, however it was the strong performance of the manufacturing sector that stands out. The sector reversed all of last month’s deterioration and posted its highest sentiment readings since March. Nearly half of UK manufacturing businesses surveyed report an optimistic own business outlook in the coming 12 months. Regionally, companies’ own business prospects improved in the Midlands and South whilst deteriorating slightly in the North.

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 net balance for manufacturing has improved to become the most confident sector overall this month. Chart C shows the manufacturing sector led the previous sentiment recovery, late last year, by 2 to 3 months. Chart D shows that all regions posted an increase in their composite net balance this month, as news regarding the euro area crisis faded recently.

Note: This month’s Lloyds Bank Business Barometer was conducted during 6-17 August 2012. The sample size was 300 companies with turnover above £1 million from all sectors and regions. Responses are re-weighted to reflect the composition of the economy.