UK factories scramble to stockpile ahead of Brexit

UK manufacturing companies are stockpiling raw materials and finished goods at greatest rate since records began as they prepare for a potentially turbulent no-deal Brexit.

After climbing in December, inventory holdings jumped at the sharpest pace in the survey's 27-year history in January, while higher demand for raw materials, input shortages and supplier capacity issues led to a marked lengthening in average vendor lead times. Jobs numbers were down during the month, only the second time since the Brexit referendum.

All in all, UK factory output dropped more than expected at the start of 2019, with the IHS Markit purchasing managers' index falling from 54.2 in December to 52.8 in January, the second-weakest reading since the referendum and suggesting the sector will drag on overall economic growth. Economists were on average expecting a reading of 53.5.

“The start of 2019 saw UK manufacturers continue their preparations for Brexit," said Rob Dobson of IHS Markit.

He said the rapid increase in input stockpiling came as "buying activity was stepped up to mitigate against potential supply-chain disruptions in coming months" and reported signs that inventories of finished goods continued to be stacked up close to the record rates in December to ensure warehouses are well stocked to meet ongoing contractual obligations.

Domestic demand for new work eased and growth of new export business slumped to "near-stagnation" as the increase in output was mainly from stock-building.

This lower domestic and export demand led to the weakest trend in production volumes for the past two and a half years, with investment goods output declining for the first time since July 2016. Output rose at consumer goods producers but slowed at intermediate goods.

PERFECT STORM BUILDING OR SOON BLOWING OVER?

Francesco Arcangeli, economist at the EEF industry trade body, warned that the manufacturers were worried about a "perfect storm" building from Brexit and a European slowdown.

“EU manufacturing PMI is also trending downwards and getting ever closer to the 50 contraction threshold. Germany moved to negative territory for the first time in more than four years and Italy remained below-50 for the fourth month in a row. Italy has now officially entered technical recession while Germany is teetering above it by an inch. This is bad news for UK exporters, with the risk of a cliff-edge Brexit increasing and global trade headwinds brewing, manufacturers will be concerned at the possibility of a perfect storm,” he said.

Barclays economist Fabrice Montagné provided a slightly more optimistic line of thought, saying that, relative to December, new orders and production eased, "suggesting emergency planning has peaked, leaving businesses in the uncomfortable position of maintaining historically high and costly inventories until resolution of the Brexit deadlock".

But once the boost to growth from this "short but intense inventory cycle is over", Barclays largely agreed with the perfect storm hypothesis Brexit uncertainty to turn into drag on profits, activity and employment, adding to external headwinds from global trade and Chinese slowdowns.

Sam Tombs at Pantheon Macroeconomics said contingency planning for a no-deal Brexit was providing some "limited support" to manufacturers at a time of weakening underlying demand, noting that the UK PMI exceeded the eurozone’s for the third consecutive month only because it was supported by the highest ever stocks-of-purchases balance, which has a 10% weight in the overall PMI.

"Component accumulation won’t boost GDP, because manufacturers primarily are stockpiling imports. In theory, the stockpiling of goods by overseas businesses could provide a short-lived boost to manufacturing output [...] All told, we see no reason to adjust our expectation that GDP growth will be below-trend again in Q1—we look for a 0.3% quarter-on-quarter print—though stronger growth lies ahead if the uncertainty created by Brexit fades soon."