Manufacturers face challenge balancing demand with production output, warns RSM UK

Commenting on the latest CIPS UK Manufacturing Purchasing Managers’ Index which has continued the downward trend, falling to 47.1 in May, Mike Thornton, national head of manufacturing at RSM UK, said: ‘The latest manufacturing PMI for May has seen another decrease, driven by the significant fall in the backlog of work index, which has dropped sharply to 38.2. This, coupled with the new orders index falling to 45.8, indicates that demand in the short term isn’t looking too bright. Should these conditions persist, manufacturers will want to avoid excessive working capital, particularly given the current high costs associated with accessing finance. Manufacturers currently face a real challenge in balancing demand with production output. 

He added: ‘More encouragingly, the input price index has fallen to 49.1, which given nervousness surrounding inflation not coming down quickly enough, shows that it is moving in the right direction for the sector. With output prices falling at a slower rate, manufacturers continue to build back margins that have been squeezed in recent times.’ 

Thomas Pugh, economist at RSM UK, added: ‘The drop in the input prices index to 49.1, which suggests that prices are now falling, is exactly what we would expect to see given the sharp falls in energy, commodity and shipping prices over the last six months. We expect this trend to continue over the rest of this year as the fall in input prices make themselves felt. This is why we expect good price inflation to fall sharply this year, dragging down headline inflation to around 4% by the end of the year. However, services inflation, which is more closely related to the labour market will remain stickier, which will be a concern for the Bank of England. Indeed, interest rates will probably now peak at 5% in the summer. 

‘That highlights the major risk facing the manufacturing sector and the broader economy. A sharp tightening in financial conditions. RSM UK’s latest middle market business index highlighted that middle markets firms found it much harder to access finance in Q2 and that the cost of finance had soared. This will make it increasingly difficult for manufacturing firms to refinance existing debts and to finance essential productivity enhancing investment. If interest rates go all the way to 5.5%, as financial markets have started pricing in, our modelling suggests that this would be enough to tip the economy into recession later this year. 

‘So, falling inflation, especially in the goods sector, gives us reason to be optimistic about the outlook for the second half of this year. But big risks, especially around interest rates remain.’