Our regular assessment of the current state of the profitability of British business and the economic factors influencing its prospects for the future,
prepared by Roger Bootle, Economic Adviser to Deloitte.

• The fall in profitability from 14.9% in Q1 to 14.4% in Q2 confirms that banks are not the only ones suffering from the financial crisis. The recent fall in energy prices will bring some relief to firms’ bottom lines. But the cyclical nature of corporate profits will still prompt them to nose-dive as the UK heads into a deep and prolonged recession. By the end of 2009, I expect profits to be around 15% below current levels.
• The sharp fall in the oil price has brought an end to the seemingly relentless rise in energy costs. The halving in oil prices from the peak of $145 per barrel to below $70 will already be reducing transport and distribution costs for many companies. 
• However, the Chart overleaf suggests that changes in oil prices affect profits primarily with a time lag of around one year. So the previous rises will still be putting downward pressure on profits for some time yet.
• And an equally important influence on profits is the sharp deterioration in the economic outlook, both at home and abroad. Indeed, the fall in the oil price is itself partly a result of weakening global growth and therefore demand for energy. 
• The turmoil in the financial markets, the previous rises in food and energy prices and the severity of the downturn in the housing market have all conspired to leave the UK economy heading for a full recession broadly similar to that in the early 1990s.
• Admittedly, weaker demand has not stopped firms from pushing up their prices in order to pass on some of their recent rises in costs. Core CPI inflation, for example, has risen from 1.2% to 2.2% over the past six months.
• But worse is to come. I now expect GDP to fall by around 1.0% next year – the first outright drop since 1991. I expect consumer spending to decline too, by around 1.5%. And a quick recovery is unlikely – GDP, consumer spending and investment are all likely to fall further in 2010.
• For a while now, the biggest cause for optimism has been the fall in the pound, which has gathered pace in recent days. Admittedly, a falling pound boosts import costs. But there is no doubt that the UK’s exporters will in time benefit from this potential boost to their competitiveness.  
• However, at least some of this boost will be offset by the deterioration in the prospects for overseas demand. The US is also heading for recession, while the euro-zone has proved that it is not as “de-coupled” from the American economy as was previously believed.
• At least the prospect of sharp falls in inflation has cleared the way for deep cuts in interest rates. Indeed, I think that they will fall to 2.5% or even lower by the end of next year. 
• What’s more, a weaker economy should help to bring down other non-energy costs too. A rise in unemployment of around 1.5 million will keep a lid on pay growth. And weaker demand for property will cause rental growth to slow.
• The upshot is that I believe that nominal profits will fall by around 15% by the end of 2010, with a sharp rise in corporate insolvencies as a result. Indeed, as with the consumer sector, a key risk is that falling profits and the consequent rise in corporate bad debts makes lenders even more cautious than they already are about extending credit to firms, which will in turn exacerbate the economic slowdown.

For further information, please contact Roger Bootle, Economic Adviser to Deloitte on 020 7823 5000.

Download the full Profitability Monitor report Q2 2008 (with supporting charts). (PDF, 174KB) 

This assessment contains general information only and is not intended to be comprehensive nor to provide professional advice.  It is not a substitute for such professional advice and should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business.  Deloitte & Touche LLP accepts no duty of care or liability for any loss occasioned to any person acting or refraining from acting as a result of any material in this assessment.