The UK recovery remains on course…
At first glance, the UK economic recovery is continuing unabated. Indeed, despite the consistent failure of exports to grow as expected, the recent revisions to the ONS’s figures suggest overall growth since 2008 has been stronger than we first thought. The EY ITEM Club Autumn forecast is very similar to the summer one with expected GDP growth of 3.1% in 2014 and growth of around 2.5% in the next few years.
Even more encouragingly, the new measure of GDP reveals that fixed investment has been stronger in the last few years than we realised. An initial analysis suggests that higher investment in IT one of the reasons for this improved view. For those of us looking for signs of a balanced recovery and an economic transformation, this is good news.
…but the global economy remains challenged.
But wherever you look in the world – and across all sectors – there are risks and potential shocks that have begun to prey on corporate confidence. And in the last few weeks, investors, politicians and business owners have started to acknowledge that the global economic still faces major challenges. China’s rebalancing is leading to slower growth and impacting both commodity and manufacturing exporters, the end of the taper by the USA has also hit emerging markets, and it is now clear just how much further the Eurozone still has to go to rebuild its economy. All of this poses real risks to the UK recovery.
UK businesses believes they can cope…
EY’s 11th Capital Confidence Barometer indicates that although UK businesses believe economic conditions are weakening and 37% of businesses cited political risk as their primary concern going forward, 93% of the UK companies surveyed are confident in their future corporate earnings, compared to 71% six months ago. How can these conflicting views on economic and financial performance be reconciled?
Drilling into the detail it appears that companies believe that the lessons learned in responding to the global financial crisis mean they will be able to manage their way through a difficult economic environment. The intention is clearly to increase the focus on operational efficiency and costs with a near 50% rise in the number of businesses intending to prioritise cost management in the 6 months since the last CCB. This more measured outlook is also reflected in the approach to M&A with all the signs pointing to cautious and limited M&A activity.
…but can they deliver?
However, as highlighted in our Q2 Profit warnings Report, profit warnings have been increasing. This seems at odds with the confidence corporates have in future earnings.
We found that in Q2 around a fifth of profit warnings were due to adverse currency movements and almost another fifth due to pricing pressures and tougher than expected competition. This suggests that corporates are either over-confident in their ability to manage, or have an unrealistic view of the environment or have inappropriate forecasting processes, or, of course, some combination of these possible explanations.
Time to revisit those contingency plans.
The priority therefore is for businesses to review their plans in the light of the current environment. In particular, there is an urgent need to evaluate the potential impact of both the Eurozone entering recession and a prolonged slowdown in the emerging markets. This should include the risk of a knock on effect in the UK, with a slowdown in investment being the most obvious risk to test.
A detailed review and analysis of the potential impact of an economic slowdown will provide the basis for identifying the nature and potential scale of major risks. It is vitally important that the review is based on a realistic view of the economic outlook around the world. Over the last 6 to 12 months, businesses appear to have slipped into a complacent view of the state of the global economy when in fact few of the fundamental indicators have improved from 12 to 24 months ago. Like the bond markets, businesses appear to have become too willing to rely on Mario Draghi and his central bank peers around the world.
This review will provide the basis for deciding on the need for contingency plans. As was the case two years ago when the Eurozone crisis first broke, plans should be developed in cases for which the potential costs of contingency planning are merited.
With appropriate contingency plans in place, businesses will then have the opportunity to consider the longer term strategic challenges posed by the economic environment. For all businesses in every sector, the question is this: is your business model appropriate for an environment of steady, unspectacular growth? With short term tactical plans in place, it is critical to consider the long term.