Our regular assessment of the current state of the profitability of British business and the economic factors influencing its prospects for the future, prepared by Roger Bootle, Economic Adviser to Deloitte.

  • At the end of last year, profitability (outside the oil sector) was still holding up reasonably well. This looks extremely unlikely to last. With GDP this year likely to suffer its sharpest fall since 1945, I think that profits will fall by a whopping 25% in 2009 as a whole. What's more, this will mask a wide variety of performances amongst individual firms and sectors. Some will actually thrive during the recession, but many more will suffer outright losses. I expect corporate insolvencies to soar above their 1992 peak of 24,000.
  • Both services and manufacturing profitability actually rose in the final quarter of last year. However, profits (gross operating surplus) in 2008 as a whole still fell by 2.6% in the services sector and by 6.4% in the manufacturing sector.
  • What's more, the extremely close relationship between GDP and profits means that it's hard to be anything but extremely pessimistic about the near-term outlook for profits. I expect GDP to fall by around 4% this year. On the basis of past performance, profits should fall by some 5 or 6 times this amount. (See Chart.)
  • The drop in the pound means that those companies that import intensively are struggling with rising import prices at the same time as slowing demand.
  • Admittedly, the surprisingly strong consumer price inflation figures since the start of the year suggest that retailers have been having some success in passing on these higher prices to consumers. We doubt that this can continue, however. The rebound on the high street at the start of this year has quickly petered out and consumer spending appears to be on a renewed downward trend.
  • Companies will therefore have to rely on cutting costs in other areas. They have recently received some offsetting benefit to their bottom lines from the sharp drop in energy costs - the oil price didn't trough until the start of this year. Meanwhile, pay freezes – or even cuts – are becoming increasingly widespread.
  • The good news is that, further ahead, 2010 is looking less unambiguously like a write-off. Policymakers have taken unprecedented action. Admittedly, the Government is backing away from plans for another fiscal stimulus in the light of concerns about the soaring level of public borrowing. However, the Bank of England's programme of quantitative easing is now well underway. Meanwhile, productivity growth should rebound if, as I expect, firms start to slash headcounts more aggressively.
  • None of this is likely to stop profits falling further in 2010, by another 13% or so. But the drop should be rather smaller than that seen this year. And profits should be rising again in 2011 – although this depends crucially on the effectiveness of the policy stimulus.
  • Meanwhile, there will, of course, be some firms and sectors that actually thrive during this recession. I expect value or budget retailers to continue to benefit from consumers "trading down." And other relatively non-cyclical sectors – such as food – should continue to outperform.
  • Amongst those companies best placed in the medium-term, however, are those which export heavily. For now, weak overseas demand and plunging world trade volumes is preventing them from benefiting from the drop in the pound. But once the global economy gets back on its feet, the UK's exporting sector will become one of the fastest-growing parts of the economy.

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