As we power ahead, what next for the UK borrowers?

Takeaways:

  • UK economy picks up steam with GDP, employment growth and government borrowing performing strongly
  • Demand for credit from UK companies is on the up, with supply gaps being filled from the increasingly established alternative funders
  • Outlook appears robust for debt capital supply, with the potential UK EU referendum a key risk on the horizon

Growth up, employment up, the budget deficit down and inflation at record lows – the UK would appear to be in a strong and accelerating position, and can now add the title of fastest growing developed world economy in 2014 to the trophy case following the most recent update from the Office of Budget Responsibility.

With inflation falling to 0% in February (the lowest since records began), the Bank of England’s (BoE) chief economist Andy Haldane has said interest rates were as likely to need cutting as raising in the immediate future, creating a new level of uncertainty around the interest rate outlook, but primarily being perceived as a delay to rate rises, despite the growing economy and falling unemployment.

Adding to the good news, the FTSE 100 index recently breached the 7000 mark for the first time in history, helped by the macroeconomic climate and Greek debt reform measures that should calm any Eurozone instability for the time being at least.  Even the prospect of the most uncertain UK general election in decades has done nothing to unnerve investors in the UK’s biggest companies.

Finally, business investment looks strong, growing by 6.8% in 2014, the largest annual growth since 2007[1], and January’s upturn in the three PMI surveys indicated an acceleration of growth for UK companies[2]. Traditional theory tells us that now would be the time for growing businesses to increase borrowing; cheap money, a rosy economic outlook and high business confidence all suggest that demand for financing should be picking up – but is this the case? And equally importantly what could be expected to happen next?

The BoE’s quarterly Credit Conditions Survey showed that credit demand from medium-sized and large companies increased in Q4 2014, with this trend expected to continue in 2015. However, whether the supply of credit has ticked up at quite the same rate to support this demand and what happens next is an interesting topic.

(Chart source: BoE’s Trends in Lending, January 2015)

Chart A
The overall availability of credit to the corporate sector was unchanged in Q4 2014 against the previous quarter according to the traditional banking lenders, and is expected to remain static in Q1 2015.  ‘Changing economic outlook’ and ‘changing appetite for risk’ were seen as the biggest drivers of change in credit availability[3] so perhaps we can expect to see an increase in willingness to lend as the economic recovery takes hold. Outside of the traditional funder backdrop, the British Business Bank continues to launch initiatives to support the undersupplied UK borrower and we see significant innovation from new market entrants, such as debt funds alongside these government-backed interventions.  Supply improvement appears to be happening, with the slack from some traditional funders being picked up by alternative funders and government initiatives.

This stable backdrop and increasing new entrants appears to be making a difference. According to the BoE’s Trends in Lending report, net finance raised by UK businesses from UK MFIs and capital markets was positive in 2014 for the first time since 2008 – suggesting that credit is beginning to flow.

(Chart source: EY ITEM Club’s Outlook for financial services, Spring 2015)

Chart B
So far, so good. But are there any plot twists on the horizon? What might unsettle this precariously positive outlook for British businesses and the credit markets in the coming years? Depending on what the country decides at the May 7th general election, an EU referendum could well be in the offing, and with it all the business uncertainty and complexities that may come with the UK being the first ever state to withdraw from the politico-economic union (albeit we have some precedence to consider with the forming of the single currency by our partner countries and our exit of the EMR). In addition we point to the EY’s UK Profit Warnings Survey which demonstrated profit warnings at a 4-year high for Q4 2014, with companies primarily stating pricing pressures, competition, and currency effects as the three most common causes for concern. However, in general, with business confidence and forecasts remain relatively supportive, and finance providers now operating in established new-norms, an EU exit appears the pick of the potential volatility on the horizon and one we want to watch closely.Looking forward, net lending to businesses is now forecast to rise almost 17% by 2018, funnelling up to an extra £66bn into UK companies over the next four years according to EY ITEM Club forecasts, supported by the growing alternative funding and stabilising traditional funder environment. Increasing credit supply appears to now be gaining momentum, from the slow burn and depressed starting point following the recession.

[1] ONS Business Investment Summary, Q4 2014

[2] Markit PMI (Purchasing Managers’ Index)

[3] BofE’s Credit Conditions Survey, Q4 2014


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