Declining profitability and cost pressures weight on UK investment

Business confidence within the service sector continued to fall in the three months to February, albeit at a slower pace than in the previous quarter according to the CBI’s quarterly Service Sector Survey. Meanwhile profitability continued to drop and cost pressures remained elevated across the service sector, with costs expected to edge even higher across the service sector as a whole in the upcoming quarter.

While business volumes were flat in business and professional services, they continued to decline for the ninth consecutive month in consumer services, although the rate of decline slowed substantially.

Employment growth in business & professional services stalled in the three months to January, but it picked up again in the three months to February, whereas headcount in consumer services remained flat for the second month running.

Uncertainty about demand continued to weigh on business investment, resulting in expected cutbacks in spending on land and buildings, as well as vehicles, plants and machinery. Nevertheless firms across the service sector expect investment in IT to grow over the next 12 months.

Charlotte Dendy, CBI head of economic Surveys, said: “There’s no doubt the services sector continues to face tough times, not least those dependent on consumer spending power during a period of high inflation and rising interest rates. Profitability is falling and costs are rising which is denting many businesses investment plans and is hitting business confidence across the sector.

“This underscores the need for serious action to build momentum in the economy at the Spring Budget. To offset the six-point rise of Corporation Tax in April and restore investor confidence, firms want the Government to replace the Super-Deduction by either introducing full expensing for capital investments or setting out a three-year roadmap to achieve exactly that.”

Business & professional services

• Sentiment about the general business situation continued to deteriorate, but at a slower pace than November 2022 (-20% from -55%)
• Business volumes were flat (+1% from -2%), following a decline in the three months to January (-13%)
• Cost pressures remain strong (+58% from +59%), and are set to grow at a slightly faster pace next quarter (+63%)
• Average selling price growth has eased slightly but remain strong (+21% from +30%), and are set to grow at the same pace next quarter (+21%)
• Profitability dropped for the fifth consecutive quarter and at a sharper pace than over the last three quarters (-27% Feb, -11% Nov, -11% Aug and -12% May). Profits are expected to decline at a similar pace over the next quarter (-30%)
• Nevertheless, employment grew in the quarter to February after growth stalled in the three months to January (+12% from +3%), with headcount growth over the next quarter expected to grow at a similar pace (+13%)
• Firms continue to see cutbacks in spending on land and buildings (-4%) and vehicles, plant & machinery (-14% a faster rate than witnessed in November). However, investment is set to take place in IT over the next year (+15%)
• Uncertainty about demand continues to be the biggest factor weighing on investment (52% from 48%)

Consumer services

• Optimism about the general business situation continued to deteriorate, but at a slower pace than November 2022 (-18% from -48%)
• Business volumes continued to decline for the ninth month running in the three months to February (-18% from -47% in January), albeit at a slower rate than the three months to January
• Cost growth accelerated in the three months to February (+73%), compared to the previous quarter (+57%). Expectations are for growth to edge higher next quarter (+78%)
• Average selling price growth has eased somewhat compared to last quarter (+31% from 41%), and are expected to continue to grow at a similar pace next quarter (+32%)
• Profitability fell for the fifth consecutive quarter (-48%), with profits expected to fall at a slightly slower rate next quarter (-41%)
• Employment remained unchanged in the three months to February (-2% from +1% in January). Headcount is set to remain flat over the next quarter (-1%)
• Consumer services firms expect to continue to cut back spending on land and buildings (-7%) and vehicles, plant & machinery (-10%), albeit to a much lesser degree than the previous quarter (-30% and -39% respectively). However, investment is set to take place in IT (+9%) after two quarters of expected cutbacks.
• Uncertainty about demand continues to be the biggest factor weighing on investment (45% from 57%).