Business volumes expand further in second quarter

Results of the Summer 2012 KBC Bank Ireland / Chartered
Accountants Ireland Business Sentiment Survey 

Main Points

• Business volumes expand further in second quarter and seem set to improve again in third quarter.
• Employment expands for first time in almost five years.
• Signs of stabilization in domestic spending drive improvement in business volume.
• Summer Survey results suggest Irish economy is seeing a gradual step-up in activity as constraints on manufacturing are offset by strength in services and somewhat healthier domestic conditions.
• With demand restrained, Irish companies look to product development and new markets to boost business volumes in coming year.
• Irish business beginning to feel more confident about outlook for Irish economy as a whole. 
• Recent EU Summit not seen producing major changes in business outlook

 
The KBC Bank Ireland / Chartered Accountants Ireland Business Sentiment Survey reflects the view of chartered accountants working in senior positions (CEO’s, MD’s and FD’s) in Ireland’s leading companies.  The survey was conducted in mid July and the results presented are based on 336 completed responses.

Spring 2012 KBC Bank Ireland / Chartered Accountants Ireland Business Sentiment Survey Results

Section I:  Quarterly Business Sentiment Survey Results

Conditions Continue To Improve Through Second Quarter

Business activity across the Irish economy improved modestly in the second quarter of 2012, according to the results of the KBC Bank Ireland/Chartered Accountants Ireland Business Sentiment Survey, sustaining the improvement seen in the previous quarter.

Conditions across Irish business continue to vary widely but, for a second consecutive quarter, more firms reported that their activity levels had increased in the past three months had declined.  As Diagram 1 indicates, positive results for the past two quarters represent a small but significant step-up in business activity compared to a sequence of fairly modest declines reported through most of 2011 and 2012.  Current conditions are also markedly better than the business environment of 2008 and 2009 when sharp declines in business activity were reported.



The Summer Survey results suggest some increased positive momentum in business activity of late.  In turn, this implies the Irish economy has moved to a point where declining output is becoming less common and increasing output more widespread.  This pattern is likely to be consistent with modest positive growth across the economy as a whole.  The contrast between positive growth reported in the Business Sentiment Survey for the first two quarters of 2012 and the negative GDP growth estimate for the first three months of the year published recently by the Central Statistics Office owes much to the surge in imports that weighed on the first quarter GDP number. Of course, it also should be remembered that the Business Sentiment Survey is constructed as a diffusion index and is designed to measure how common or different conditions are across sectors and the economy. Through 2011, the strength of the multinational sector drove a positive GDP outturn even though conditions across most of the spectrum of Irish business remained weak. The Summer Survey implies healthier business conditions are now being seen on a broader scale. Indeed, somewhat healthier domestic activity appear to be offsetting the impact of weaker global conditions.

The improvement in Irish business conditions remains uneven.  It should also be emphasized that the improvement in the second quarter of 2012 was driven primarily by a reduction in the number of firms reporting a drop in activity rather than an increase in the number of firms reporting stronger activity of late.  This result is not entirely unexpected but it serves to emphasize the exceptional nature of current Irish economic circumstances.  In a normal recovery, an upswing would tend to be driven by a progressive increase in the number of firms seeing stronger demand for their output.  In the Irish economy of 2012, the emerging improvement owes more to a gradual easing in the influence of a range of negative factors that resulted in lower business volumes in recent years.  The strength of these forces produced a downturn of exceptional intensity and breadth and will also act to restrain and influence the shape of the recovery. The Summer Survey hints that period of almost uninterrupted climb in domestic spending stretching almost five years may be coming to an end. This would be a key ingredient in any turnaround in the Irish economy as a whole.

The Summer Survey suggests we are seeing a gradual easing of ‘feel bad’ influences but a broadly based ‘feel good’ has yet to take hold.  As a result, the stabilization process in the Irish economy is taking a fairly long time compared to a more normal business cycle when a surge in ‘animal spirits’ tends to drive a rapid acceleration and broadening of the recovery.  Of course, the hesitant nature of the turnaround is also hugely influenced by recurrent bouts of weakness in Ireland’s key trading partners and elevated uncertainty about the future that are restraining new investment and hiring.  Indeed, when these factors are taken into consideration, the improvement evident in the Summer Survey has to be regarded as very encouraging.

As has been the case through most of the near six year history of the Business Sentiment Survey, conditions differ considerably across business sectors.  For the Summer 2012 survey, the most positive responses in terms of output in the past three months came from food related businesses.  There was a strong reduction in the number of firms in this industry reporting weaker activity and a broadly similar increase in the number of firms signaling stronger activity in the second quarter.  This notably stronger positive activity balance meant the food sector eclipsed the business services sector as the strongest area of activity of late.  That said, the activity balance in business services was slightly stronger in this Summer Survey than that reported of three months ago.  So, there appears to be a solid forward momentum to activity in this area that likely reflects the influence of both domestic and export activity in the business services sector. In contrast, manufacturing firms reported only a marginally positive activity balance in the current survey that fell some way short of the strong positive balance in the spring.  Presumably, this reflects the impact of global economic concerns on the output of companies in this area.

Perhaps surprisingly, firms in the construction sector reported a marginally positive balance in the current survey in contrast to pronounced weakness in this area through most of the past five years.  While, we would caution against exaggerating the significance of this particular result, it is consistent with a small pick-up in house building volumes reported in National Accounts data for the first quarter of 2012.  It also chimes with a number of other indicators that hint a bottoming out process in construction may now be underway. Survey results for the second half of 2012 should help confirm whether the picture in construction is set to change from the sharp and sustained declines in activity reported through the history of the Business Sentiment Survey.

The Summer Survey saw a further weakening in business conditions for firms dealing with Irish consumers.  This is not unexpected given the constraints on consumer spending power, concerns about the prospect of further budget austerity measures and the effects of poor weather through the early summer on household purchases of seasonal items.  However, compared to the Spring Survey, there was a marginal rise in companies in this sector reporting stronger activity and a marginal decline in companies reporting weaker conditions.  These results are broadly in line with retail sales data that show a further fall, albeit at a reduced rate, in the second quarter of 2012.

The small negative balance for the consumer sector in the Summer Business Sentiment Survey appears consistent with the view that consumer spending might be approaching a point of stabilization.  After the declines of the first half of the year, any looming stability would still be consistent with a significant drop in Irish consumer spending for 2012 as a whole. However, as in the case of construction, a period of stability or relatively marginal changes in consumer spending would represent a notable improvement in the business climate in this area compared to the experience of recent years.

Activity Set To Improve Further As 2012 Progresses

Building on the improving trend in recent quarters, Irish businesses expect to see a further increase in activity in the next three months. Diagram 2 indicates that in contrast to results for the past three months, forward looking responses are driven primarily by an increase in the number of firms anticipating stronger activity rather than a drop in the number of firms expecting further declines in their business volumes.  If the expectations of the 43% of companies who see their output increasing are realized, this would translate into a palpable improvement in the business climate in Ireland.  An increasingly difficult and uncertain global environment argues for a measure of caution in relation to this finding but these results should be regarded as pointing towards a gradual pick-up in the Irish economy through late 2012 and into 2013.



Looking at the sectoral detail, manufacturing firms continue to report a positive activity balance for the next three months (i.e. more firms expect output increases than declines) but compared to responses to the same question in the Spring Survey, there has been a sharp increase in the number of firms that anticipate a contraction in their output and a small decline in the proportion of businesses that envisage an increase in activity.  So, the survey hints at a continuing negative impact on Irish manufacturing from poorer conditions abroad.

a strongly positive activity balance for the coming three months but this reflects significant and broadly offsetting increases in both the number of firms anticipating increases and the number predicting declines in output in the third quarter.  Again, this result highlights a persistent finding of the survey that the experience of firms, even those who operate in the same sector, can differ sharply.  The positive expected activity balance in the business services sector also increased in the Summer Survey relative to three months ago.  This result seems consistent with the view that a generally more positive environment might be expected to translate relatively quickly into increased demand in the business to business area particularly as the operations of many Irish companies have become relatively ‘lean’ through the downturn.  So, any step-up in demand for their output may feed quickly through to additional purchases from other firms. Of course, the business services area includes some of the more dynamic export companies now based in Ireland as well as firms focused primarily on the domestic market.

The Summer Survey also shows a strongly positive expected activity balance in the construction sector.  This was somewhat stronger than the marginally positive balance seen in the previous survey, an assessment that seems to have been borne out by construction companies’ views on how their business volumes developed in the past three months.  These results partly reflect the exceptional fall in construction output in recent years and seem to suggest that a bottoming-out process is emerging in this area. We don’t think these results should be interpreted as pointing to any marked increase in construction output in coming months.

The Summer Survey was also notable for a marginally positive balance in expectations among businesses focused on Irish consumers.  Again, this contrasts with the slightly negative forward looking balance reported by firms in this area three months ago and points at least tentatively towards an emerging stabilization in activity in this sector.

Although it may take another quarter or two of data for clear confirmation, the Summer Survey suggests domestic demand may be starting to stabilize.  The more positive answers to survey questions given by firms in the construction and consumer sectors suggest sharp declines in activity in these areas may have come to an end and more mixed conditions may be beginning to take hold. The fragility of domestic spending power and ongoing uncertainty about the Euro area crisis argue against simply extrapolating these encouraging results through the remainder of 2012 and into 2013.  However any easing in what have been important negative influences on Irish economic activity would represent an important change in economic conditions.  This should also translate into a step-up in the measured economic growth rate in 2013.

New Hiring Now Exceeds Firing
 
The continuing increase in business activity in the past three months and expectations of a stronger increase in the coming quarter translated into a reasonably solid improvement in the jobs element of the Business Sentiment Survey in Summer 2012.  These results represent the first positive jobs balance since the Winter 2007 Survey. As Diagram 3 shows, this improvement was largely driven by a significant increase in the proportion of firms that said they had added to their payrolls in the past three months. These results appear consistent with a spate of job announcements in recent months, positive jobs elements in a number of other surveys and the strength of income tax receipts. This might suggest some companies had been overly aggressive in cutting headcount and now need to re-adjust.

While the Summer Survey results represent a significant improvement, it needs to be emphasized that not all sectors or companies shared in this change. There was a small decline in firms reporting a drop in employment but, as Diagram 3 indicates, a still significant 21% of firms reported that their payrolls had declined.  So, layoffs continue in many areas as companies adapt to continuously changing business conditions.  We should also point out that companies reported somewhat weaker expectations for hiring in the next three months that may reflect uncertainty about the European economy and its impact on activity levels in Ireland in the months ahead.  Together with a relatively unchanged layoff rate, this implies only a marginally positive employment balance for the third quarter of 2012.  It is understandable that firms are adopting a relatively cautious stance in relation to their future employment needs. Taken together, the backward and forward looking employment elements of the Summer Survey suggest that firms are matching headcount decisions to actual rather than anticipated needs. Companies remain focused on staying ‘lean’. So, there appears little prospect of a surge in employment unless demand conditions strengthen markedly.



The sectoral details of responses to the jobs question show food firms moving to a positive employment balance after net layoffs in the previous three months. There was also a further strengthening of the positive hiring balance in manufacturing.  Consistent with the results they gave to questions on activity, firms in the construction section also reported an improvement in employment while there was a marked decline in the negative jobs balance among firms focused on consumers.  Although firms in the business to business area continued to report a comparatively strong employment picture, the positive balance in this sector was unchanged from the Spring Survey with slight increases in both the numbers of firms that reported increases and decreases in payrolls. Again, this underlines how conditions vary from firm to firm.

Cost Concerns Beginning To Fade

The more positive assessment of business conditions seen throughout the Summer 2012 Business Sentiment Survey may in part have been driven by a reported easing in cost pressures.  Following the generally deflationary conditions that prevailed through 2009 and 2010, Irish companies had to deal with a sharp step-up in costs through 2011 and into the early part of this year.  However, as Diagram 4 shows, the Summer 2012 Survey a notable reduction in the number of firms reporting higher costs and a clear increase in the number of firms reporting a drop in costs in the past three months.  A small further reduction in cost pressures is expected in the coming quarter in spite of the possible impact of a weaker Euro exchange rate on the prices of imported goods and services.



The improvement in the cost climate in the past three weeks was felt most strongly in Food and Other Manufacturing and presumably owes much to the recent easing in energy prices.  There was also a sharp decline in the number of business services firms reporting higher costs and a significant increase in those reporting reduced costs of late.  Conversely, construction firms reported higher costs as did consumer focused businesses even though the consumer sector saw some narrowing in the gap between the number of firms reporting higher and lower costs.

Sentiment Towards Irish Economy Strengthens

Most aspects of the Summer 2012 Business Sentiment Survey are encouraging but a particularly striking result is the sharp improvement reported in sentiment in relation to the Irish economy as a whole which is shown in diagram 5.  The main focus of the KBC Bank Ireland/Chartered Accountants Ireland Business Sentiment Survey is on the direct experience of companies. However, the broader economic environment is a very important influence on the business decisions they take.  At a time when uncertainty about the global economy has increased, these survey results contrast markedly with barometers of business confidence in a range of other countries.  To some degree, this may reflect how difficult Irish macroeconomic conditions have been in recent years. This probably makes it somewhat harder for Irish businesses to downgrade sentiment further.  However, that wouldn’t explain why sentiment has been upgraded in the Summer Survey.  Instead, this improvement may reflect tentative signs that the Irish economy has now moved to a somewhat less painful stage in an ongoing adjustment process, that some of the painful measures adopted by companies in recent years are bearing fruit and that this progress is translating into somewhat healthier demand conditions of late for the goods and services that Irish businesses produce.

Again, it bears repeating that the particular circumstances faced by individual businesses vary widely and nearly a quarter of companies felt less optimistic than three months ago. However, as Diagram 5 shows, the positive balance overall in responses to this question represents a notably changed judgment compared to the experience of recent years.  An improvement in sentiment compared to the Spring Survey results was seen in all sectors.  The strongest positive responses came from the business services sector while positive balances among construction and consumer focused firms were notably better than responses given in the Spring Survey.  Again, this might be interpreted as hinting at an emerging stabilization in domestic demand.



In contrast to all other areas, firms in the food sector continue to report a strongly negative balance in terms of sentiment towards the Irish economy as a whole, even if the results in the summer survey were better than those of three months ago. The negative balance for this sector stands in contrast to relatively positive balances in terms of these firms own output. This may reflect concerns about some of the more contentious aspects of reform to the Common Agricultural Policy or comparatively large cost pressures of late in this industry.  Manufacturing firms reported a relatively modest positive balance, a result that probably reflects the particular influence of global concerns.  However, the Summer Survey results represent an encouraging improvement from the negative balance reported by this sector three months ago.

Section II – Supplementary Questions

EU Summit Unlikely To Be A “Game Changer” For Business

As usual, the Summer Business Sentiment Survey included a number of additional questions.  A couple of these related to the perceived significance of the end June EU Summit that saw a number of steps proposed towards closer European integration and a commitment made to improve the sustainability of Ireland’s banking related debts.

We wanted to see if Irish business felt these developments would have significant consequences.  The results set out in Diagram 6 suggest expectations in this regard are very limited.  On the question of the impact on medium term prospects for the Irish economy, opinions were split.  A significant 24% of respondents were uncertain about the likely effects of the summit. Of the remainder, a somewhat greater number (42%) felt there would be no material change than thought there would be some lasting impact (34%). 

This split breakdown appears to underline the continuing confusion that surrounds many if not most developments in the Eurozone.  Perhaps more significantly when asked whether the recent summit would prompt a change in companies’ own medium term prospects, only 5% felt they would alter their business plans whereas an overwhelming 85% said they would not alter their business plans in response to the summit.  Positive responses to this question tended to be concentrated among companies in the semi-state and business service areas but even here negative responses dwarfed positive replies.

Increased Business Activity reflects firms own efforts

We also asked a number of questions about firms’ expectations in relation to the demand conditions they might face in the next twelve months.  These results are summarized in Diagrams 7 and 8.  As Diagram 7 indicates, just 31% of respondents don’t expect a material improvement in the demand for the goods and services that their companies produce. So, sentiment overall is strongly positive in regard to output prospects for the coming year. That said, only a relatively modest 18% see this improvement coming as a result of natural growth in the markets they serve.  A significant 18% felt that product development undertaken by their company will be the key driver of an increase in business volumes in the coming year while a broadly similar number (16%) expect growth to come through an expansion into new markets.



Not surprisingly, manufacturing firms tended to attribute more of their anticipated growth to product innovation and entry into new markets than did firms in other sectors.  Manufacturing firms were correspondingly more pessimistic on prospective natural growth in the markets in which they operate.  Perhaps surprisingly firms focused on consumers also repeated a relatively high dependence on product innovation to drive increased business volumes but firms in this area were relatively downbeat on demand prospects overall. So, these results may suggest that necessity is indeed the mother of invention.  Food firms also tended to be relatively downbeat in terms of their expectations for demand and also placed comparably greater hopes on developing new markets while business services firms and construction companies felt natural market growth would play comparatively large roles in growing their business in the coming year.

We also asked companies what they expected to be the major factors restraining growth in their business in the next twelve months. These results are presented in Diagram 8.  Broadly consistent with the answers shown in Diagram 7, some 32% of respondents felt that weak market demand would be the major factor restraining their business volumes.  Manufacturing and food firms tended to emphasize this answer.  A relatively small number (14%) don’t see any constraints from weaker demand in the coming year.  Perhaps surprisingly, these tended to be in domestic-focused sectors.  This result probably, reflects an improvement related to the exceptional weakness of recent years. A substantial 24% of respondents cited poor sentiment and uncertainty as the major constraint facing their business. Again, this indicates how different conditions are at present to a more traditional business cycle. This factor tended to figure fairly consistently across all sectors but firms in the food sector and in property cited it more frequently than others.  Credit constraints were mentioned by just 14% of firms, with construction companies expressing particular concerns in this area.  In keeping with answers to the question on costs in the main part of the survey, most firms did not see cost issues as a critical constraint.  However, competitiveness issues were mentioned by significant numbers of firms in the business and consumer areas.  These responses may reflect company or product specific issues rather than ‘macro’ competitiveness problems as firms in predominantly traded areas such as manufacturing and food tended not to see competitiveness is as a key concern.

Drawing together responses to the two questions on expected demand, it appears Irish companies don’t anticipate major growth in the markets in which they operate in the next twelve months.  Companies are responding to a lack of natural buoyancy by branching into new markets and developing new product lines to support their further growth.  So, Irish companies are not waiting passively on a rising economic tide to lift all boats. Instead, they continue to change what they produce and where they sell it in order to deliver stronger business activity in the year ahead.