Business sentiment falls on Greek exit fears

Corporates' confidence regarding UK economic prospects fell back sharply in May, falling 47 points from a net balance of 26 per cent to -21 per cent, according to the latest Lloyds Bank Wholesale Banking & Markets Business Barometer. This fall is largely reflective of a decline in the share of companies that were optimistic about the economy (48 per cent falling to 22 per cent) and an increase in companies that were negative about the economy (22 per cent increasing to 43 per cent). It seems that the re-emergence of concerns within the Eurozone, first seen in April's data, have had a major impact on the confidence of companies in May.

Although businesses' sentiment on their own prospects has also fallen, it is only a slight fall back in comparison to the sentiment towards the broader UK economic outlook. Businesses' confidence in relation to their own prospects currently stands at 35 per cent, down eight points on April's 43 per cent.

Although sentiment has worsened, it is worth noting that the scale of the fall in part reflects the improvements witnessed since the beginning of the year and this is evidenced by the sentiment for May remaining higher than that seen in December 2011 and that it remains higher than during the worst of the financial crisis in 2008/09.

Our economists' model of future GDP performance based on the most recent survey data suggests an ‘underlying' 0.2 per cent growth will be witnessed in 2012Q2 GDP, once the effect of the Diamond Jubilee - which may result in a reduced quarterly growth of around 0.5 percentage points - is taken into account. However, unless business sentiment improves in the coming months, aided by improvements in Euro area economic prospects, underlying growth in Q3 may weaken anew despite an expected bounce from Olympic spend in that quarter.

Profit margins, prices and employment

The net balance for employment prospects fell two points to 21 per cent from 23 per cent a month ago, adding to last month's five point fall, but this is still significantly higher than the low of 9 per cent from last December. Profit margins rose marginally in May, improving two points to -15 per cent from -17 per cent in April, whilst the net balance for average domestic prices edged back slightly from 13 per cent to 7 per cent. There was an improvement in profit margins, despite the six-point fall in domestic prices, suggesting that lower costs supported margins.

Sectors and regions

The ‘composite index', which is based on aggregating the findings for the economic prospects, trading prospects, employment prospects and profit margins, provides a comprehensive overview of a region or sector's sentiment. This month's data shows broad based declines in the composite index across all sectors and regions, with the most notable declines witnessed in the North and Midlands and in the retail & distribution sector. There was a narrowing of the gap between the North and the Midlands with the South.

Trevor Williams, chief economist, Lloyds Bank Wholesale Banking & Markets, said: "The renewed concern around the Eurozone is clearly having an impact on businesses' sentiment towards prospects for the UK economy and, to a lesser extent, to their own prospects. Despite this, our model still points to a return to positive underlying growth in Q2, excluding the Diamond Jubilee effect. However, until the challenges facing the Eurozone are resolved, the risk that underlying GDP will weaken in Q3 cannot be discounted, notwithstanding the natural ‘payback' from the Q2 bank holiday effect."