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UK business investment enters recovery with positive outlook

The outlook for UK business investment is potentially very positive as the economy recovers from the impact of COVID-19, according to a report by the EY ITEM Club. Following a 10.2% contraction in UK business investment in 2020, April’s EY ITEM Club Spring Forecast predicted investment will climb 7.1% in 2021 and 10.5% in 2022. The firm's latest analysis finds that, despite the economic impact of the pandemic, some sectors increased investment in 2020. Further, a number of factors have now aligned to create the potential for strong future UK business investment growth.

While the impact of lockdown restrictions and the pandemic contributed to some economic sectors - such as mining and quarrying (-52%), construction (-39%), and engineering and vehicles (-35%) - seeing significant falls in business investment in the fourth quarter of 2020 compared to a year earlier, other sectors delivered sizeable growth.

Efforts to combat COVID-19 with vaccines, track and trace, and distanced workplaces, a shift to remote working and learning, and the move to online shopping all helped push up investment in transport and storage (up 34%), education (22%), IT and communications (15%), real estate (10%), and the health sector (5%). As a whole, the services sector increased business investment by 6% between the fourth quarters of 2019 and 2020.

Looking ahead, the EY ITEM Club says that business investment is set to be further supported by the end of Brexit uncertainty in many sectors, sizeable amounts of cash accumulated by the corporate sector over the last year, the possibility of rapid consumer spending growth, government commitments to increased public investment and levelling up the UK economy, and the likelihood of continued historically low interest rates.

"The prospects for UK business investment are looking much better coming out of the pandemic than at any point since before the financial crisis," said Peter Arnold, an EY UK Economic Advisory Partner. "In context, while the decline in business investment in 2020 was significant, it shouldn’t be over-emphasised: it was only slightly deeper than the pandemic-driven 9.8% fall in GDP. By contrast, the 15.3% decline in business investment in 2009 amid the financial crisis was three times greater than the 4.1% GDP contraction that year. A key factor supporting business investment this time around is that the pandemic did not limit bank lending in the same way that we saw during the financial crisis - instead, we saw the opposite. The banking sector entered the pandemic well-capitalised and funding has been readily available to support businesses and households. The economic effects of the pandemic have also been felt most in less capital-intensive sectors, like hospitality."

Businesses are entering the recovery with cash to invest

The EY ITEM Club's analysis says that non-financial UK companies raised £77.7bn in additional finance between March 2020 and April 2021 - over three times the £23.9bn of net new finance raised in the 14 months to February 2020 - and issued equity and bonds worth a net £49bn.

Positively, businesses have already started to repay some of their new liabilities, with additional net finance peaking at £87.6bn in February 2021 and corporate net borrowing slightly negative in the 12 months to April 2021. And, as a share of GDP, corporate debt by the end of 2020 was still lower than the pre-financial crisis record.

The availability of finance, combined with government support and some businesses cutting spending on wages and other expenses during the pandemic, led to non-financial companies’ bank deposits rising by £129.5bn between March 2020 and April 2021 – an increase £111bn higher than if the average monthly increases of 2018 and 2019 been repeated.

While companies' cash holdings have fallen in past recessions, this time many UK businesses will find themselves with a significant amount of capital ready to invest in the recovery. They’re in a similar position to UK households which, overall, have built up a record savings pot. The availability of capital to invest is one of a number of reasons why the prospects for business investment are bright. That households have plentiful savings at their disposal combined with a revival in confidence bodes well for consumer spending. Fiscal austerity has been replaced by a focus on repairing the economic damage of COVID-19, which may create opportunities for businesses. Uncertainty over the future of the EU-UK trading relationship, which dragged on investment in the late-2010s, has been resolved, to a point. Against this backdrop, there is a potential for a higher-pressure economy in the next few years than the UK has seen for some time.

"The experience across different sectors will vary," commented Martin Beck, senior economic advisor to the EY ITEM Club. "Increased use of homeworking is likely to promote IT and communications spending, although sectors like commercial real estate may see less investment as a result. Meanwhile, the persistence of social distancing measures and the combined impact of Brexit and the pandemic on the number of foreign-born workers in the UK may lead to investment in automation across a number of sectors. While the picture for business investment is relatively positive, there are still grounds for caution. Higher levels of debt might affect future borrowing capacity and may mean investment is crowded out by higher interest payments. And, given the pandemic has capped off an unpredictable economic decade, psychological caution could run-deep, prompting a hesitant approach to investment even during the economic recovery. The key question is whether optimism can be sustained long enough for businesses to reset their expectations and factor in a more promising future. To help in achieving this, policymakers should be careful not to withdraw fiscal and monetary support too soon."

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