Resilient businesses to rebuild margins as economic outlook improves, but ‘slowcession’ still a risk

RSM UK Middle Market Business Index (MMBI) Q1 Update:

• RSM UK’s latest MMBI (Middle Market Business Index) shows 39% of businesses feel the economy has improved over the last quarter
• Over half (54%) expect the economy to continue to improve over the next quarter, a significant jump from just 38% last quarter
• Appetite among middle market firms to invest has increased, with over half (59%) ramping up capital expenditure over the next six months
• 61% of businesses are planning to recruit, while labour hoarding is also common
• Almost half of businesses (45%) say their net profits are up compared to last quarter

Despite the largest interest rate rise in a generation, middle market businesses are demonstrating remarkable resilience, investing in people and productivity to rebuild profit margins. RSM’s latest Middle Market Business Index (MMBI), the first economic index to focus solely on middle market* businesses in the UK, has risen to 131.4 in Q1, an increase of 16 points, and the largest rise since the index began.

The first MMBI of 2023 shows middle market leaders are more positive about the economic outlook compared to last quarter’s data, with 39% saying the economy has already improved, and 54% expecting it to improve over the next quarter, a significant jump up from 38% last quarter. 

Thomas Pugh, economist at the leading audit, tax and consulting firm RSM UK, said: ‘The good news is the anticipated recession will be mild by historical standards. The overall drop in GDP will probably be around 1%. That’s around half the size of the early 1990s recession, significantly smaller than the global financial crisis, and a fraction of the pandemic, when GDP fell by a massive 22%. This means the next year will feel more like a ‘slowcession’ than a typical recession.

‘The rise in businesses expecting the economy to improve suggests renewed positivity, but we are not out of the woods yet. Business leaders should plan for another drop in economic growth, and inventory management is key to weathering the storm. Leaders should also focus on the recovery in the second half of the year, as businesses that invest in their people and productivity now will be best placed to benefit from the upswing when it arrives.’

Encouragingly, over half (59%) of middle market businesses plan to increase capital expenditure and investment over the next six months, and over half (58%) anticipate that turnover will increase.

There is evidence that firms are holding on to employees even though they have less work, opting to reduce their hours rather than lay them off and then having to recruit at a later date. While the unemployment rate has risen to 3.7%, it is still low given the current macroeconomic weakness. The tight labour market, and concerns about recruitment struggles, could explain why 48% of businesses hired more staff in Q1, and 61% say they are planning to recruit over the coming six months.

RSM UK’s latest MMBI also shows almost half (45%) of business leaders say their net profits are already up compared to last quarter, while 60% said they expect their net profits to increase over the next six months, a rise from 47% last quarter.

The data shows that some middle market firms are passing on costs to their customers. Almost half (48%) of businesses said they raised prices in Q1, while 64% said they intended to raise prices in the next six months, up from 57% in Q4. This is a key factor in why profitability increased significantly in Q1, with 45% saying net profits had increased, compared to only 35% in Q4.

One potential risk to many middle market businesses is excess stock accumulation though. Almost half (45%) of middle market businesses said they were holding more stock now than in the last quarter, up from 34% in Q4.

Thomas Pugh points out: ‘Carrying too much stock ties up working capital and can force firms to discount in order to clear their shelves, harming margins. This increase in stock levels is particularly concerning because demand for goods is likely to decrease over the next six months as consumers absorb the one-two punch of a sharp increase in interest rates and a fall in real incomes.’

There are encouraging signs that the huge ramp up in costs is abating, and middle market businesses are rebuilding their margins. With inflation still in double digits, unsurprisingly the data shows around two thirds (67%) of businesses paid more for their inputs in Q1 than last year. Inflation is now falling though, and this is likely to continue throughout 2023, as the Bank of England tries to reach its inflation target of 2%.

Thomas Pugh concludes: ‘We would caution that a recession has most likely been delayed, rather than totally avoided. The combination of double-digit inflation, huge rises in interest rates, and less fiscal support from government means household disposable income will shrink significantly. Even if the UK does avoid recession, growth is likely to be extremely weak, and the economy is unlikely to be back to its 2019 size until 2024 at the earliest. While there’s signs of light at the end of the tunnel now, there’s still a few bumps in the road ahead for middle market businesses.’

RSM’s MMBI presents unique insight into the health of the middle market – the engine room for growth in the UK - whilst drawing on credible forward-looking indicators to deliver predictive economic insight over a six-month period.

For further information and to view the report visit Home Page - MMBI (rsmuk.com).