UK SME business activity returns to growth

Business activity at UK small and medium-sized enterprises (SMEs) expanded at the fastest rate for seven months in December, led by renewed growth in the service economy. Adding to signs of a steady turnaround in business conditions, new orders stabilised at the end of 2023, which ended a five-month period of reduced workloads.

The headline NatWest SME PMI^® Business Activity Index registered 51.2 in December, up from 50.7 in November and the highest reading since May. This signalled a marginal overall increase in SME business activity, with growth in the service economy more than offsetting sustained declines in manufacturing and construction output. The latest fall in manufacturing production was the steepest since October 2022, reflecting weak demand in both domestic and export markets.

Survey respondents often commented on relief at the pause in Bank of England interest rate hikes last autumn, alongside a positive impact on business and consumer spending from lower borrowing costs and easing inflationary pressures. This contributed to an improvement in business activity expectations for the year ahead. Overall business confidence among SMEs was the highest since early-2022, helped by a marked improvement in service sector optimism at the end of last year.

Elevated wage pressures and squeezed margins meant that UK SMEs were wary about adding to their staffing numbers. Job creation stalled in December, which ended a 33-month period of employment growth. A number of firms commented on the non-replacement of voluntary leavers due to spare capacity and efforts to contain business expenses.

Input cost inflation accelerated to its highest since September, which was overwhelmingly linked to greater salary payments. December data also signalled a robust rise in prices charged by SMEs, led by those operating in the service sector, largely in response to higher operating expenses.

Meanwhile, the latest NatWest Sustainable Business Tracker indicated that 35% of UK SMEs viewed sustainability action as a high priority for the year ahead, down from 36% in Q3 and the joint-lowest since the survey began in 2020.  A slide in prioritisation was reported by both manufacturers and service providers, with survey respondents often commenting on the need to focus on rising business expenses and challenging economic conditions. In contrast, the proportion of large enterprises citing sustainability action as a high priority rose from 59% to 64% in Q4.

Finally, our special feature on obstacles to sustainability actions in 2024 illustrated that worries about higher business costs were by far the most prevalent constraint cited by UK SMEs. Around 60% of the survey panel noted that rising business costs was a major obstacle to becoming more sustainable in the next 12 months. Difficulties measuring carbon footprint were the second-highest ranked barrier, reported by 31% of SMEs in Q4.

Large enterprises also noted that rising business costs (59%) were the top ranking obstacle for 2024, while uncertainty about government regulation was the second-highest cited constraint on sustainability action (37%).

Sebastian Burnside, NatWest chief economist, said: “Small businesses are starting 2024 on a positive footing with confidence getting back to pre-energy crisis highs. Costs are clearly a concern and rising wages, especially the national minimum wage, means businesses are going to be working hard to find efficiencies this year. That may mean sustainability initiatives slide down the priority list for some, but investments in energy efficiency will make even more sense for others. The market’s expectations of interest rate cuts may also help lower financing costs, if the Bank of England builds more confidence that inflation is falling reliably.”

James Holian, head of business banking at NatWest Group, said: “After a turbulent year for the economy, it is really encouraging to see that small businesses ended 2023 in higher spirits, with growth accelerating at the fastest rate since May. The services sector in particular has been buoyed by strong sales in the last quarter as borrowing costs have eased. With business confidence now at its highest level in over a year there’s a real sense of momentum as we start 2024.

“For those businesses looking to improve their environmental sustainability, rising business costs remain the biggest challenge. At NatWest we have developed the tools to support businesses to understand where they can improve their energy efficiency and save money, so they can concentrate on the day-to-day running of their business.”

Obstacles to sustainability goals in 2024

NatWest asked businesses to report on obstacles that UK SMEs face in becoming more sustainable in 2024.

Of the ten potential barriers covered by the survey, rising business costs were cited as the biggest challenge for SMEs when looking to improve their environmental sustainability. Six-in-ten SMEs noted this as the largest obstacle, with manufacturers more likely to report this as a constraint than services companies (66% versus 54%).

Furthermore, the proportion of SMEs stating rising costs as a barrier was nearly double that recorded for the next biggest obstacle; the inability to accurately measure their carbon footprint (31% of all SMEs).

A number of companies reported that suppliers, particularly those based overseas, were often unable to provide information on their carbon emissions, which made it challenging to calculate their companies’ overall footprint.

A lack of customer demand for more sustainable products (26% of all SMEs) and difficulties in making a business case for sustainability in terms of cost savings (25%) were also key concerns.

While rising business expenses were also the main concern among large companies when it came to future sustainability goals in 2024 (59%), uncertainty around government regulation placed second in the rankings of top obstacles. Around 37% of large firms reported uncertainty around government policy as a constraint on sustainability plans for the year ahead, compared to 30% of SMEs.