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Summer 2017 business sentiment survey strongest for six quarters
Details suggest recovery is continuing to broaden and reaching more sectors and companies
Firms cautious on new hiring but headcount reductions at record low
Rebound in confidence suggests slowdown fears related to Brexit and possible US policy changes haven’t materialised
Little sign of broadly based overheating concerns or capacity strains as business conditions ‘normalise’
Survey suggests Brexit planning has been to the fore in Irish business thinking of late
77% of firms have a sense of likely Brexit impact on their operations with more than half of these already taking action
Irish business sentiment improved notably in summer 2017 to its strongest reading since late 2015. The pick-up was driven by stronger business activity levels of late and a further easing in concerns about the outlook for the Irish economy.
The KBC Bank Ireland/Chartered Accountants Ireland business sentiment index rose to 118 in the summer quarter from 110.6 three months earlier. The latest increase marks the fourth consecutive quarterly gain which means the index has recovered to levels seen before the UK Brexit vote or the increase in uncertainty about US policy intentions but sentiment remains notably softer than the recent series peak of 131.1 recorded in late 2015. While fears have eased, continuing uncertainty means companies remain cautious.
The increase in Irish business confidence in the past three months is largely a reflection of a healthier trend in business volumes and in the broader Irish economic backdrop than might have been feared. As diagram 1 indicates, the trend in the sentiment survey tends to reflect the broad contours of Irish GDP data (with the understandable exception of the 2015 step-shift). In this respect, the data suggest that positive momentum is still building. However, the details of the summer survey particularly in relation to job creation suggest that companies are responding to still elevated levels of uncertainty by adopting a relatively cautious approach to expansion plans.
The summer survey suggests there has been a clear pick-up in Irish business activity levels in the past three months. As diagram 2 below shows, there was both a rise in the share of companies reporting higher output volumes and a decline in the share of companies reporting weaker conditions. Encouragingly, the drop in negative responses exerted the larger influence. The fact that only 8% of companies reported declining output of late suggests a further widening of the basis of the recovery across Irish businesses and also hints that any adverse impact from currency movements or uncertainty related to Brexit has been reasonably contained.
All of the main sectors of business activity reported a widening gap between the number of firms reporting stronger activity and those reporting declining business volumes. The sector reporting the largest increase in rising activity levels was construction where positive responses jumped to 85% of those surveyed from 48% in the spring survey. This was quite exceptional. In the case of firms focussed on consumers a 4 point rise in positive responses exceeded a 2 point fall in negative responses but, in other sectors, the drop in the number of firms reporting weaker activity was clearly larger than the rise in firms reporting stronger conditions.
As noted above, these results could be interpreted as suggesting that the recovery in the Irish economy has now developed to the point where it is being felt much more widely across businesses. It may also be that activity has corrected of late after an earlier pull-back related to Brexit uncertainty and currency effects. This would be consistent with a less dramatic and later slowdown in the UK economy than was initially feared.
The improvement in activity in the past three months likely contributed to an upgrading of expectations for the coming quarter. However, as diagram 3 illustrates, the change envisaged in activity is relatively modest. Furthermore, the improvement is concentrated in a further drop in the number of firms that see their activity levels weakening.
The number of firms that expect a drop in their output in the next three months has fallen back towards the series low seen in late 2015/early 2016 and suggests increased confidence in the resilience of the Irish economy as well as a sense that Brexit or US related concerns have moved a little further into the future than previously envisaged. It could also be the case, as we discuss in section 2, that a significant number of firms have made some progress in assessing and responding to the specific implications of Brexit for their operations.
The improvement in activity levels in the past three months and the expectation of further increases in the quarter ahead might be expected to underpin a positive trend in the employment component of the survey and the evidence presented in diagram 4 suggests this to be the case. However, as the diagram shows, the survey also seems to be highlighting some distinctive features that the Irish jobs market is exhibiting of late.
Diagram 4 points towards a slightly softer trend in the number of firms reporting that their workforce had increased in recent quarters. In the summer quarter, the share of firms reporting higher headcount stabilised in spite of a further improvement in business volumes. We think that two factors may be responsible for this development.
The first is a continuing caution in relation to hiring that has seen the jobs element of the business sentiment survey consistently lag the recovering trend in business activity in recent years. The likelihood is that this hesitation to commit to higher headcount would have been amplified of late by uncertainty in relation to Brexit and possible US policy shifts. The weaker tone of new hiring in areas such as manufacturing and food companies would seem consistent with such sensitivities. A second consideration might be higher labour costs which were identified in some responses to additional questions asked in the summer survey and discussed in section 2 of this analysis.
We did also consider that this softer trend might reflect emerging skill shortages because of the cumulative strength of the recovery in employment in recent years. A further survey question found that with the exception of business services most sectors reported some easing in the difficulty in finding suitably qualified candidates for existing vacancies in the past three months. This could reflect a broadening recovery that is now seeing increased demand for less skill-intensive roles. This might also be consistent with the relatively contained increase in income tax receipts thus far in 2017.
However, diagram 4 also indicates a notable reduction in the proportion of firms reporting a reduction in their headcount in the past three months to the lowest number in the survey’s history. This would seem consistent with the clear drop in the share of firms reporting weaker conditions and, as such, appears to testify to an increasingly broadly based recovery in the Irish economy and a greater confidence that this can be sustained in coming quarters. In a sense, these results might suggest a stepdown or ‘freeze’ in pre-emptive hiring and firing of late in the contrasting circumstances of increasingly robust conditions at present but prospects that remain significantly clouded. Firms may be cautious in relation to increasing their payrolls because of a fear of the unknown but they seem equally determined not to shrink staff numbers because of the strains that would cause in filling healthy order books at present.
A notable feature of the summer business sentiment survey was a clear improvement in confidence in regard to the broader Irish economy. As diagram 5 indicates, the pick-up in this element was notably greater than that reported in firms’ own activity levels. To a significant degree this reflects the fact that companies’ have been clearly more positive about their own immediate operating environment of late than they have been about general Irish economic prospects, particularly since the UK vote to leave the EU.
As recent news about the Irish economy has consistently exceeded expectations (and, in many instances, the performance of key trading partners has also been better than feared), Irish companies have been progressively upgrading their assessments of the general economic climate. This change in thinking was characterised by a marked drop in negative views on the economy particularly from firms in sectors such as food, manufacturing and construction that might have been more focussed on emerging threats to the recovery through the past year or so. In contrast, for businesses focussed on consumers, responses were primarily driven by a marked increase in positive views that likely reflects a strengthening trend in consumer spending.
As noted above, a key element of the summer business sentiment survey results is the resilience of firms’ own activity levels and the recovery in confidence about the broader Irish economy. Circumstances such as these have prompted concerns in some circles that the current trajectory of the Irish economy might mean it is in danger of ‘overheating’. To get a business perspective on such risks we asked respondents to the summer survey to indicate whether they felt that capacity issues might now be an issue for their own firms.
We attempted to gauge whether companies judged that either the current level or the pace of growth in their business volumes was particularly strong. The responses set out in diagram 6 below do not suggest that Irish business is currently experiencing any marked strains that might warn of overheating threats. About 70% of Irish companies feel that their current operating levels are normal and not developing in a manner that would suggest an unsustainable pace of growth in their output. Consequently, current conditions might be described as a ‘normalisation’ of activity as the recovery after a severe downturn becomes more mature.
Only 6% of respondents suggested they are now operating above normal levels while a further 6% reported a particularly rapid pace of growth at present. Overall, slightly larger numbers reported below normal operating levels (8%) or weakening trends (5%) of late. Those responses citing above normal growth were concentrated in construction and property sectors although firms focussed on consumers did report an above average trend towards rapid growth of late.
These results may be indicative of emerging strains in specific areas but they don’t appear to support the contention that the Irish economy is at risk of overheating in the ‘macro’ sense of broadly based pressures on productive capacity. In a follow on question, some 60% of respondents felt that in terms of demand conditions relevant to their customer base Budget 2018 needs to inject some additional spending power into the economy whereas 10% of firms felt some withdrawal of spending power would be appropriate.
We also sought to examine whether overheating risks might be suggested by a widely rising trend in costs. As the responses shown in diagram 7 below indicate, trends in business costs appear reasonably subdued with only 6% of firms characterising their costs as rising rapidly while 46%-the largest proportion of respondents, indicated their costs were broadly stable. No sector showed any marked tendency towards widespread rapid cost increases with fewer than 10% of firms giving this response in all sectors but firms in food, property and consumer facing businesses were somewhat more likely to report rapid increases than other sectors.
We then asked firms what cost areas had shown pressures of late. As the bar chart in diagram 8 indicates, 67% of companies indicated pressure on wage costs are increasing. It should be noted that the wording of this question refers to ‘clearly increased costs’. As such, these responses do not necessarily imply a rapid or necessarily worrisome trend in these costs. There may be some element of catch-up at play after a subdued trend in wages in recent year that has seen the wage share of national output (whether measured by GDP or the newly produced GNI*) consistently decline through the Irish economic recovery. However, in the context of a generally restrained cost environment, Irish wage trends bear watching.
As has been the case in recent KBC Bank Ireland/Chartered Accountants Ireland business sentiment surveys, we included a question on Brexit to establish how business responses to this issue are evolving. Responses shown in Diagram 9 below suggest that there continues to be some variation in companies’ assessments of the impact but the large majority of firms-some 77% of those surveyed now feel they have a strong or some sense of what Brexit may mean for them. In turn, this means just 23% of companies indicated they have little sense of what Brexit might mean for their business. While this is not a negligible number, it likely includes many firms with little or no direct exposure to Brexit.
Half of those reporting a strong or some sense of the impact—some 38% of respondents to this question indicated that they have already taken what they deem to be appropriate action. Of the balance, it may be that some envisage no material impact while others may feel that they can’t take action until the UK leaves the EU or there is greater certainty about the precise form the UK’s post exit relationship with the EU will take. Even among the 23% of companies who reported that they have little sense of what impact Brexit might have on their business, a significant portion, some 9%, have already taken action.
We would interpret these results as suggesting Brexit considerations have figured prominently in Irish business thinking of late. Moreover, this has progressed to the point where significant numbers- some 45% of companies surveyed, report they have already taken action to deal with the expected impact Brexit will have on their operations. This is an encouraging result in that it suggests that Irish companies have not been deflected by media reports of little progress in the UK’s exit negotiations or the possibility of an extended transition period before the UK’s exit from the EU. Instead, according to the survey, they have been proactive and progressed their own preparations significantly.
Reflecting the pervasive nature of Irish business links with the UK responses to this question did not show extreme variations between sectors. Indeed, a more notable feature was the broad consistency of the tone of responses across a range of sectors. However, there were some clear if undramatic differences between sectors and a potentially more worrisome divergence within some sectors.
Firms in the food industry tended to have a clearly stronger sense of Brexit implications than other areas and a higher propensity towards action than elsewhere. Manufacturing and Construction also tended to have above average numbers of firms indicating both a strong senseof the likely Brexit impact and a correspondingly high number of firms indicating they had already taken action. While the number of consumer focussed firms reporting a strong sense of the Brexit impact and action taken was above average, this sector also reported a relatively large share of firms with little sense of the likely impact and a correspondingly high level of inaction.
Overall, however, the summer business sentiment survey suggests Irish companies are actively engaged and, in many instance, have made significant progress in preparing for this major change in their operating environment. This might be regarded as a positive result and suggests Irish companies have not deterred by the pronounced lack of detail emerging from the initial stages of the formal Brexit negotiations.
In part, companies’ active engagement on this issue may have been forced by the impact on their operations of the sharp weakening in Sterling through the past eighteen months. However, the survey results might also suggest engagement with a range of advisory information from Irish government and other sources. To the extent that these responses hint at an early and informed discussion about firm and sector specific issues, it should enhance the capacity of Irish business to face this major challenge.
This non-exhaustive information is based on short-term forecasts for expected developments in the economy and financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalised investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a judgment as of the date of the report and are subject to change without notice.