UK business confidence: still not quite confident enough

Confidence is the Uk economy is increasing and  the focus shifting to growth…

UK business confidence has soared over the last year and UK plc is now more confident in the economic outlook than at any time in the last 2 years according to the recently completed 9th EY Capital Confidence Barometer: a sample of around 1,600 business leaders, 10% of whom are drawn from the UK.  This confidence appears to be based on solid foundations as 84% of respondents expect the UK economy to grow at between 1 and 3% in 2014, in line with consensus forecasts, suggesting that businesses are basing their plans on an informed view of the economic outlook.

This new-found confidence in the economy is translating into  a much more positive attitude to growth: 64% of the UK businesses surveyed describe their focus as “growth”, up from 36%  a year ago, a higher proportion than the global average increase. This translates into  increased expectations to pursue acquisitions, with 37% expecting to pursue an acquisition in the next 12 months, a 10% increase since April. Our analysis of historic data on survey responses and historic deal activity suggests an increase in intentions  of this scale should lead to  activity within the year.

…but not growth as we know it…

However, despite the increasingly positive responses, doubts as to the speed and scale of any pick up in activity loom large  when we look at the detailed thinking  behind the growth plans. The underlying sentiment remains very risk averse:

  • 33% of companies will focus on core products for their growth but only 12% envisage investing in more riskier  R&D led growth as the way forward;
  • Only 12% of companies will rely on expansion into new growth markets as their primary route to growth;
  • Deals will be relatively small compared to the pre-crisis period – 90% of companies expect to do deals of a value of $500 million or less and only 4% of companies are contemplating Billion dollar deals.

While expectations are that there will be  a slight increase in debt to fund deals, the increase is very slight and we are clearly not on the verge of a return to the boom years of investment and acquisitions. UK business is planning to expand in a very measured and incremental way.

Why is business being so cautious? Is it because the severest financial crisis in a generation has sapped confidence amongst corporate decision makers or are other factors at work?

…because the world has changed

The confidence that business has in the economic outlook is not reflected in its sentiment on future earnings. Confidence in future profitability fell from 63% to 42% amongst UK respondents in the last 6 months and this will is certain to act as a dampener on investment intentions. As management emerges from the worst financial crisis in a generation, it remains very sensitive to potential downside risks and the default position is to wait whenever there is uncertainty.

However, other developments in the business environment  may be  even more significant  in restraining investment. Two themes we have identified are reputation and political risk.

One of the most striking findings from our survey was the increased focus in the boardroom on risk management, regulation and especially corporate governance in the last 6 months. The scale of the change is extremely large and clearly reflects an increased attention on these issues – the focus on corporate governance increased from 50 to 63% of boardrooms – a major jump. In the last 6 months businesses have seen the continuing moves to regulate the banking sector, the continuation of a major international debate on taxation with several companies singled out for criticism,  a number of high-profile corruption allegations and controversies over UK energy policy. Against this backdrop, it is no surprise that boards are working to ensure that they have the appropriate risk and governance approaches in place and are determined to ensure they do not damage their reputations through ill-judged activity. Government needs to be aware of the potential dampening effect of its decisions on business investment and to ensure all initiatives are well thought through and balance the benefits of change against the costs.

Respondents to our survey also highlighted political risk in the global economy as  a major concern. As the global economy has slowed so the failure of many governments to drive through structural reform as their economies boomed has become clear. With slower growth, governments have less flexibility in resource allocation to address social concerns and to head off any potential  unrest and so the risk of political and social disruption is greater than in the recent past, or at least business is more aware of the risks. Investment today requires an assessment of the ability of governments to drive through structural reform and to manage the domestic political environment successfully. This is another layer of uncertainty and hence another barrier to investment.

Conclusion: recovery precariously balanced

The UK recovery has started but as the EYITEM Club Autumn forecast highlighted, it will only be sustained if business investment follows the consumer upturn and creates the jobs and opportunity for wage growth that will support the increased consumer debt. UK business can see the improving environment but the barriers to action remain significant and it is clear that things could go either way. the next 6 months will be crucial as we wait for the emergence of bold, first movers to break the deadlock.

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