By Max Clarke

Producer price Inflation (PPI) is on the rise as firms seek to pass on costs, though export orders are driving a recovery in UK manufacturing, the has CBI said today.

Of the 394 manufacturers that responded to the January Quarterly Industrial Trends Survey, 32% had seen an increase in output over the past three months, while 16% said that it had fallen, giving a balance of +16%, compared with +9% in October. This was driven primarily by growth in export orders (+13%), with domestic demand rising more modestly (+9%). Domestic demand growth was, however, stronger than had been anticipated in October (+2%).

Over the next three months, output is expected to grow at a similar pace again (+17%), driven primarily by another strong rise in export orders, with a balance of +18% of firms expecting export orders to increase. Domestic orders are expected to be broadly flat (-3%). When asked about likely output constraints over the next quarter, fewer companies cited orders and sales (68%), the lowest since July 2007.

Manufacturers have raised output prices markedly during the last quarter. Both average domestic and export prices rose at the fastest pace since October 2008 (balance of +13% and +14% respectively). Looking to the next quarter, price increases are expected to accelerate sharply: a balance of +31% of firms expect domestic prices to rise alongside +34% for export prices. The latter balance is the highest since January 1995 (+34%).

This acceleration in output prices reflects the fourth successive quarterly rise in average unit costs (+26%), with cost pressures expected to continue to rise at a similar pace over the next three months too.

The jobs situation continued to improve as +8% of firms said that staff numbers had risen in the past three months, the second consecutive quarter in which this survey balance was positive. But manufacturers expect little change in headcount over the next quarter (+2%).

In line with the strengthening in orders and output, sentiment has also improved. A balance of +7% of firms said that they are more optimistic about the business situation than three months ago, while +18% were more optimistic regarding export prospects for the year ahead.

Ian McCafferty, CBI Chief Economic Adviser, said:

“The recovery in the manufacturing sector is firmly in place and looks set to continue. Production has been boosted this quarter by a strengthening in both domestic and overseas demand and, over the next three months, companies expect further growth, driven by another rise in export orders.

“It is also encouraging to see that employment prospects in the sector have risen for the second consecutive quarter and manufacturers’ confidence is improving.

“But manufacturers have come under intense pressure to pass on rising costs: they have increased prices markedly in this quarter, and expect to raise them at an even faster pace over the next three months. This will drive further inflationary pressure in the wider economy.”

In line with the improving demand outlook, manufacturers’ investment intentions have strengthened. Investment in plant & machinery is expected to increase over the next twelve months for a balance of +10%, and companies also plan to spend more on training and retraining (+19%), and on product and process innovation (+22%) over the coming year. Compared to the previous year, firms no longer plan to reduce their capital expenditure on buildings over the next year, with the survey balance (+1%) the highest since July 1997 (+2%).

The improving outlook for investment is driven by a pick-up in capacity utilisation and less stringent finance conditions.

The number of firms working below capacity has fallen (59%) compared with October (64%), and is now back in line with its long-run average. In addition, significantly more firms plan to expand capacity through investing more over the coming year (41%).

Financial constraints to investment are easing. The number of manufacturers citing inadequate net returns as a factor likely to limit capital expenditure over the next year fell from 37% in the previous two quarters to 28%, the lowest since the series began in October 1979. Fewer firms highlighted internal finance shortages as a factor expected to restrict expenditure. In addition, credit and finance was highlighted by half as many manufacturers as a likely hindrance, compared with the October survey.

Monthly data from the survey showed that 21% of manufacturers said that total order books were above normal, while 37% said that they were below. The resulting balance of -16% is down on December (-3%), but is still slightly above its long-run average. Overseas demand remains stronger however, with export order books reported to be in line with par (0%), albeit down slightly from December (+4%).