Hard Brexit worries hit Irish business confidence

Section I: Repeated Questions

Activity slows as uncertainty grows

The KBC Bank/Chartered Accountants Ireland business sentiment index dropped to 99.4 for the three month period ending in mid-October from the previous quarterly reading of 114.2. As diagram 1 illustrates, the autumn 2018 reading is marginally lower than the 99.9 reading seen in autumn 2016 in the immediate aftermath of the Brexit referendum in the UK and, as such, is the lowest since the winter 2012 figure of 92.9.

It should be emphasised that this result does not mean that the level of business activity in Ireland has slipped to a six year low. Instead, the survey suggests that the pace of growth in activity and the mood of business have fallen back markedly towards those that prevailed in late 2012. So, the survey is pointing towards a clear change in sentiment to the point where caution rather than confidence dominates business thinking at present.

The autumn survey saw a marked easing in the range of Irish companies experiencing activity growth in the past three months. To recall, the survey differs from most other metrics in that it provides a snapshot of conditions across Irish business at a point in time rather than an aggregation of activity based on the relative scale of companies output.

As diagram 2 indicates, it remains the case that notably more companies (42% of respondents) experienced increased business volumes in the past three months than had seen their activity shrink (16%) but the gap between positive and negative responses is now narrower than at any time since 2013. As such, the survey tentatively suggests some companies may now be adopting a ‘wait and see’ approach and tempering expansion plans or hiring until there is greater clarity about the outlook for the year ahead.

The softer profile of business growth of late was broadly based although food firms were an exception in reporting an acceleration in growth in the past three months. There was a notable softening of growth across firms in manufacturing and construction that may reflect sector-specific issues; the influence of global trade tensions and slower growth in the Euro area in the case of manufacturing and capacity constraints in the case of construction.

The most pronounced weakening in the pace of growth in the past quarter was reported by companies focussed on consumers. This reflected a significant drop in the number of companies reporting higher output and a broadly comparable increase in the number of firms reporting weaker output. This result hints at significantly poorer conditions in the consumer sector but it may, in part, be due to notably more pronounced and short lived seasonal peaks in spending patterns of late. In this context, the survey dates likely didn’t capture peak summer spending while more recent months may be subdued ahead of the now substantial ‘black Friday’ boost to sales.

Irish based companies see business conditions improving in the final three months of the year but the future pace of growth is now seen modestly lower than in the previous survey. As diagram 3 below illustrates, expectations are seeing a downgrade similar to that seen in the immediate aftermath of the Brexit referendum in 2016 but the gap between positive and negative responses to this question remains wide and indicative of ongoing gains in business activity levels.

Across sectors, expectations for the final quarter of 2018 broadly mirror the reported experience of the past three months. Construction firms, in particular were more cautious about the near term outlook but there was also a clear downgrading of growth prospects by manufacturing and consumer focussed firms. In contrast, the outlook foreseen by companies in the food and business services areas was similarly positive to that of three months ago.

A somewhat slower pace of growth of late and a more cautious outlook prompted an easing in the pace of hiring. However, as diagram 4 below illustrates, the changes in the past three months have been marginal and the autumn survey is still consistent with a very healthy jobs market in Ireland of late.

All sectors continue to report significantly positive employment balances, signalling that notably more companies in each area are adding to rather than reducing their payrolls. That said, with the exception of the food sector, responses pointed towards a broadly based if modest cooling in the hiring climate of late.

The largest pullback in hiring was seen in construction which likely reflects significant capacity constraints. As companies in this area did not report particularly sharp increases in skill shortages in the past three months, this slowdown may not be entirely due to a shortage of construction workers. It could reflect other supply-side constraints on growth (such as the availability of suitable sites, planning or financing issues) or some increased caution reflecting a more uncertain ‘macro’ outlook.

Confidence hit by Brexit concerns

The consistent message of the various elements of the business sentiment survey that capture respondents assessments of their own companies’ operating conditions is that activity levels continue to improve solidly even if there has been a clear if modest easing in the pace of improvement of late. However, the autumn survey also revealed a marked downgrading of the broader Irish economic backdrop by business of late.

Each quarter, the business sentiment survey asks respondents if they have become more optimistic or pessimistic about the broader Irish economy in the past three months. The specific wording of the question implies we are primarily interested in changes in the mood of business (rather than whether companies are broadly positive or negative). So, the responses shown in diagram 5 below suggest Irish companies have become notably less confident about the general economic outlook of late.

The results shown in diagram 5 suggest sentiment about broad economic prospects has weakened sharply in recent months. While the change in thinking is not as dramatic as that seen around the Brexit referendum in 2016, it still represents a major mood shift particularly in circumstances where the message from most economic indicators is pointing towards robust growth at present.

Our sense is that this drop in business confidence owes much to the increasingly public political impasse that points to rapidly diminishing prospects for the previously widely expected ‘soft and smooth’ Brexit.

We also think that the relatively recent memory of the crisis and its continuing financial impact on many households and firms also means Irish companies remain acutely sensitive to downside risks. The key unknown is whether the current assessment of economic prospects proves excessively optimistic or pessimistic and this will likely be resolved by the final outcome of the current Brexit negotiations.

Booms, Brexit and Budget 2019

As usual, the autumn survey asked a number of additional questions focussed on some topical issues.

We began by asking companies their opinion as to how economic growth next year might compare with 2018. To get a broad sense of the economic environment and avoid any unnecessary complications that might follow from numerical estimates of Irish GDP, we phrased the question in general terms and asked whether growth in activity and employment was likely to strengthen or weaken next year.

The answers, illustrated in diagram 6 below, suggest that opinions vary widely but almost half (47%) of those companies surveyed see the pace of growth slowing in 2018. In contrast, a significant 29% expect growth to accelerate while 22% see the Irish economy maintaining the current momentum of improvement.

Views on the broader Irish economy are likely influenced by the sectors in which companies operate. Domestic focussed firms in areas such as construction and consumer goods and services in particular tended towards more pessimistic responses while food and manufacturing firms were comparatively optimistic.

We went on to ask what firms considered to be the key threat to business in the coming year. While the intensified focus on Brexit ahead of the mid-October EU summit may have heightened concerns, the message of the survey in terms of economic risks is unambiguous. As diagram 7 indicates, Brexit dwarfs all other concerns at present.

Worries about over-heating (9%), domestic costs (4%) and housing (8%) highlight other domestic issues while US economic policy is also noteworthy (8%) but the scale of these scores and those of the other areas highlighted compared to those for Brexit emphasise the extent to which Brexit is perceived as an unclear and present danger to Irish economic prospects.

Brexit was considered the major economic threat by all sectors. This result might seem slightly at odds with CSO data that show only about 35,000 enterprises of the roughly 260,000 operating in Ireland trade directly in goods with the UK (separate Revenue estimates that may include firms at various stages of the supply chain as well as those engaged in services activities put the number trading with the UK at around 72,000). However, the autumn survey reflects how pervasive Irish-UK business links are as well as how widely Brexit is seen to threaten Irish economic prospects.

A strong sense of the interconnectedness of Irish and UK business conditions is suggested by a comparison of the KBC Bank/chartered Accountants Ireland business sentiment index with the UK CBI’s monthly trend enquiry order book balance. The latest UK data for October were released earlier this week and showed an unexpected fall – at the fastest pace in three years-see light blue dashed line in diagram below.

The nature of the sentiment survey as an indicator of conditions across Irish business means this correlation with conditions in the UK is likely to be notably stronger than that seen conventional production or trade indicators that tend to be dominated by the activities of a small number of very large scale multinationals operating in Ireland.

As diagram 8 below suggests, there tend to be strong similarities between business conditions on either side of the Irish Sea. Brexit threatens both this relationship and the broader health of conditions in the two countries.

If Brexit is seen to pose a major threat to Irish economic prospects Budget 2019 is judged to be of only limited significance to the outlook for the year ahead. As diagram 9 illustrates, some 82% of companies see Budget 2019 as being of little or no importance to their business prospects in the year ahead.

The market sector where the Budget is seen as most influential is for firms focussed on consumers. Perhaps surprisingly, relatively few construction companies focussed on the Budget while manufacturing was the area with the largest complement of firms seeing no Budget impact on their activities.

Consistent with these results, some 76% of respondents said Budget 2019 would not make it more likely that they would take on additional employees but 8% of businesses, concentrated in food and business services, said they were more likely to increase hiring as a result while the remaining 16% were unsure at this point.

Some 62% of firms felt that Budget 2019 didn’t alter the capacity of the Irish economy to cope with Brexit but a broadly based 19% said it modestly helped in this regard while 7% see it worsening the situation, with construction and consumer focussed firms over-represented in this respect.

_{NOTE: As was the case with the summer survey, the sample size in this survey is somewhat smaller than usual because we wanted to frame the time window to include the period immediately after Budget 2019 but to limit it to ensure consistency of responses in regard to Brexit. The change in sample size has only a minor impact on the confidence intervals around the survey results.}