Manufacturing output weakest in eight months as interest rates take their toll

Rising interest rates have begun to bite UK companies, with a majority of businesses reporting the weakest output levels in eight months, according to a survey.

A monthly business tracker, compiled by Lloyds, found that 13 of 14 sectors said they had suffered from falling new orders last month, citing high inflation and climbing borrowing costs as the reason for weaker output. “In the face of higher interest rates and still relatively rapid price rises, businesses and consumers are being more careful about how they spend their money,” Nikesh Sawjani, senior UK economist at Lloyds Bank, said.

“This suggests that interest rates are having their intended effect. Output in the private sector is only marginally expanding, and it’s clear that many businesses are downgrading their expectations for future output growth as they settle in for what they believe will be a period of price pressures that are stronger than hoped and may last for longer than previously anticipated.”

There is growing evidence that the rapid pace of interest rate rises is beginning to hit the economy, 18 months after the Bank of England first began tightening its ultra-loose monetary policy. Latest figures on the jobs market this week showed an unexpected rise in unemployment, falling employment and a narrowing in open jobs vacancies in response to higher rates.

Rising borrowing costs deter companies from investment and hiring and can eventually lead to an increase in the jobless rate. Consumers are also encouraged to save more and spend less when interest rates and inflation are high, helping drive down demand and inflation.

Lloyds’ tracker found that software services was the only sector of the economy that did not suffer from falling new orders, with the likes of chemicals manufacturing and car production and transport suffering some of the biggest monthly drops. Ten out of 14 sectors said overall production contracted last month.

Official figures released this week showed that headline consumer price inflation dropped from 7.9 per cent to 6.8 per cent last month, with energy costs driving down overall price growth. However, inflation in the service sector and food rose, suggesting that some parts of the economy were still raising prices.

The survey found that businesses think sticky inflation will hit their performance this year, because consumers will hunker down in the face of a prolonged cost of living squeeze. Other surveys have shown that companies are still raising costs to consumers in an attempt to rebuild margins eroded by high inflation and surging energy costs.

Scott Barton, managing director at Lloyds Bank, said: “A sustained softening of demand may lead businesses to adapt their pricing strategies in order to attract, and retain, customer spend, resulting in a more intense and competitive environment. However, firms will be wary of the increased pressure this could place on margins. It’s crucial that any changes to pricing strategies are accompanied by watertight cashflow.”

Financial markets expect the Bank of England to continue its aggressive monetary tightening by raising interest rates twice more this year, taking the base rate to a potential 6 per cent.