Tougher economic conditions hamper UK business confidence

The quarterly study, which surveys 1,000 chartered accountants across the UK, reported a confidence index of 6.1 for Q2 2023, a marked improvement from Q1’s score of 2.5, but still below the pre-pandemic average of 7.2 for the years 2010 to 2019.

ICAEW Chief Executive Michael Izza (pictured) says that the current challenges faced by businesses, including high inflation and successive interest rate rises, have had a significant impact on business confidence: “The drop-off in optimism during the survey period reflects what our members tell us about the problems that they face.”

He added: “The report also makes for rather sobering reading for the property and retail sectors, both of which are exposed to high interest rates clearly weighing on sentiment.”

Property sector hit the hardest

The survey revealed that domestic sales growth has slowed to its lowest level since Q3 2021, contributing to the decline in business confidence. Interest rate increases in May and June have also played a part in dampening sentiment.

Confidence in the second quarter was only negative in the property and retail and wholesale sectors, reflecting their direct exposure to rising interest rates and, for the former, a weakening housing market. Property companies also recorded the second-lowest domestic sales growth of all sectors.

Input prices rose at their fastest rate since the survey began in 2004, but businesses expect input price inflation to ease sharply in the year ahead due to falls in the cost of both energy and raw materials, ICAEW says.

Selling prices also rose at their fastest-ever rate in the second quarter, with manufacturers, retailers and wholesalers reporting the biggest increases. However, companies expect selling price inflation to drop to its lowest level since Q4 2021 over the next 12 months, reflecting the slowdown in input costs.

Wages hit new heights in IT and communication companies

Salary growth gained momentum in Q2 and is now at a BCM record high rate. IT and communications companies have seen the largest wage increases, reflecting their continued need for highly-skilled people. The pace of salary growth is expected to weaken over the next 12 months, but only slightly compared with the pattern seen in input and selling price inflation.

ICAEW Economics Director Suren Thiru expressed concern over the economy’s lacklustre performance in the second quarter, attributing it to high inflation, record wage pressures and rising interest rates, which have all dampened business confidence and domestic sales.

“While the marked easing in firms’ pricing expectations suggests that inflation will continue dropping back, the impact of historically high wage costs points to the headline rate remaining stubbornly above the Bank of England’s 2% target well into 2024,” Thiru says.

“Our figures suggest a difficult second half of 2023 with mounting concerns over rising interest rates, a higher tax burden and waning customer demand all likely to weaken activity in the months ahead.”

Regulations and customer demand key challenges

The survey also highlighted the challenges posed by regulatory requirements, with 37% of businesses facing growing issues. Respondents cited increased regulatory scrutiny alongside growing reporting requirements and administrative burdens as primary concerns. Sectors including retail and wholesale highlighted issues relating to Brexit requirements, while businesses in the banking, finance and insurance sector cited concerns about Financial Conduct Authority regulation.

Another major challenge for businesses is customer demand, with more than a third of respondents pointing to slowing sales and an uncertain economic background; 29% of respondents said they had been affected by the rise in corporation tax to 25% in April, while bank charges and access to capital were also cited as significant problems, especially for companies in the property sector.

Additionally, capital investment spending growth has slowed, and businesses anticipate further moderation in the year ahead due to the prevailing fragile business confidence.

ICAEW said that to boost confidence, the government must formulate a plan to deliver long-term growth by increasing the resilience of the UK economy and the transition to net zero, in a way that enables small businesses to operate more sustainably in a difficult economic environment.

ICAEW’s Izza said: “It’s time for a government plan to deliver a growing and resilient economy which enables businesses of all sizes to operate effectively.”

Following the latest update from the ICAEW Business Confidence Monitor, Mike Randall, CEO at Simply Asset Finance said: “Confidence is continuing to improve this year, as ICAEW’s data shows businesses remain optimistic for their profit growth over the coming year. While the data shows reasons to be cheerful, it’s also evident business challenges aren’t disappearing overnight, and a large majority are clearly feeling the squeeze from corporation tax increases earlier this year. This is particularly the case for SMEs, of whom over a third have growing concerns about the corporation tax rise, alongside already existing economic headwinds.

“Nevertheless, while capital investment remains low, this will likely soon change as positive sentiment returns in industries key for the UK’s growth. Transport, manufacturing and engineering are among those remaining optimistic for the year ahead, and with targeted financial support to spur their growth, we only hope to see this increase in the following quarter. With challenges still on the horizon – especially for smaller businesses – a combined effort from specialist lenders, and the government to inject much needed funding into key industries will be needed to improve confidence overall.”

Neil Rudge, Head of Enterprise at Shawbrook, said “Confidence continues to recover amongst UK SMEs in Q2 despite two increases in interest rates during this period. Predictions that we are now reaching the peak of the interest rate curve will help to reassure SMEs planning for the next six months and beyond. A confident SME sector is vital for the UK, helping to put the country on a stronger footing, supporting productivity and growth as businesses feel more secure in making critical investment decisions.

“Despite positive indications, there remain some potential headwinds. The industrial action across the public sector points to a potential continuation of wage inflation and labour challenges for the foreseeable future, and the enduring war in Ukraine continues to put pressure on energy prices and global supply chain logistics. For businesses seeking capital in the planning phase, flexibility remains a key priority to ensure sufficient manoeuvrability in uncertain times. We continue to see increased demand for specialist solutions such as asset-based lending and leveraged debt which allow SMEs room to operate as conditions change.”