By Marcus Leach

Sentiment among UK manufacturers deteriorated in the past three months, as confidence was hit by stagnant output, falling demand and concerns over exports, the Confederation of British Industry (CBI) said.

However, a slight rise in export orders and modest growth in output are expected in the next three months.

Of the 387 manufacturers responding to the latest CBI quarterly Industrial Trends Survey, 27% said output rose, while 26% said that it fell. The resulting rounded balance of +2% showed that production weakened sharply in the three months to January.

In the next three months, manufacturers expect output to rise modestly, with a balance of +15%. However, the latest result was affected by sharp swings in production in the chemicals sector. If chemicals production were excluded, the extent of both the downturn and the rebound would be less pronounced.

Broader conditions in the manufacturing sector remain fragile.

Domestic and export orders both fell for the first time in two years. The fall in domestic orders (a balance of -17%) was the first since January 2010, and the decline in export orders (-19%) was the first since October 2009.

But in a sign that fears over global demand are beginning to ease, firms expect to see a slight rise in export orders (+4%) and a levelling out of domestic orders (-3%) in the coming quarter.

In the monthly data from the survey, firms considered total order books to be below normal (-16%), but to a lesser extent than in the past three surveys. Export order books were also considered below par (-26%), but to a lesser extent than in either December or November.

Nonetheless, sentiment about the general business situation and export prospects fell sharply for the third consecutive quarter. Alongside falling demand, confidence was hit by growing concern over political and economic conditions abroad. This rose sharply as a factor likely to hamper export orders in the next three months (to 39%), now well above the long-run average (21%).

Sentiment was also affected by the continuing concern over export credit. Even though credit or finance fell back slightly on October’s survey as a factor likely to limit export orders (13% compared with 18%), it remains considerably above the historical average (5%).

“We know that 2012 will be not be an easy year. The watchword continues to be uncertainty. The crisis in the Eurozone is still hanging over the UK, threatening future growth. With large amounts of peripheral countries’ debt maturing in the coming months, Eurozone stability is far from assured," John Cridland, CBI Director-General, said.

“Nevertheless, within this survey there are some tentative signs that things could improve somewhat in the coming quarter. Key factors behind this include the fact that the US recovery has been better than expected, and the impact of the credit rating downgrades in the Euro area has been muted.”

Stocks of finished goods were unchanged in the past three months (0%), following three quarters in a row where firms have built up inventories, and no change is expected again in the next three months (0%). The adequacy of finished goods stocks (+14%) is in line with its long-run average (+14%).

Numbers employed in manufacturing rose unexpectedly, (a balance of +11%) making this the sixth quarter in a row of rising headcount. However, firms expect no change to employment (-1%) in the coming three months.

Even though firms still plan to spend less on both buildings and plant & machinery relative to the past 12 months (with balances of -18% and -6% respectively), investment intentions have not deteriorated any further. Indeed, planned spending on product innovation and training & retraining remains significantly positive.

“It is clear from this survey that conditions in UK manufacturing remain fragile. However, the steepness of the slowdown in growth this quarter was partly caused by the specific issue of destocking further up the chemicals supply chain, and the instant impact on output in the sector," Ian McCafferty, CBI Chief Economic Adviser, said.

“While the acute fears seen at the end of last year over global demand may be subsiding, 2012 will prove to be a difficult year for UK manufacturing, as the crisis in the Eurozone — our biggest export market — has yet to reach any definitive resolution.”

Manufacturers’ export prices were flat (-3%), following the first decline in October (-7%) since January 2010. Domestic prices rose a little (+7%), but continued to be outpaced by the growth in average unit costs (+27%), albeit lower than its peak during the middle of last year.

In the coming quarter, firms expect domestic price inflation to pick up (+13%), while export prices are set to remain flat (+1%). A slower rise in costs is expected (+14%), which would relieve some of the recent pressure on firms’ profit margins.

Elsewhere, capacity utilisation changed little from October; only a slightly lower proportion of manufacturers were working below capacity (54%) than in October (58%). Expanding capacity has fallen back as a motivation for investment, now closer to its long-run average.

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