Geopolitics looms large

A personal view from Debapratim De, Deloitte’s Chief Economist in the UK. To subscribe to this weekly newsletter, click here.

Geopolitics looms large

We promised to share the results from our latest Deloitte CFO Survey with you last week. Unfortunately, their public release was delayed. Therefore, I am covering the key findings in this week's briefing.

Chief Financial Officers of the UK's largest businesses continue to rate geopolitics as the biggest risk facing their firms. It has now consistently topped their risk list for more than three years.

The latest Deloitte CFO Survey was conducted between 17th September and 1st October - a period marked by escalations in the US-Iran conflict, with Houthi attacks on Saudi Arabian cities and oil installations, and growing speculation over a US ban on diesel exports. The price of crude oil averaged over $100 a barrel during the period, adding to concerns over inflationary pressures and further monetary tightening.

CFO perceptions of risk mirror these developments, with the prospect of further interest rate rises and higher energy prices ranked as the second and third biggest risks to businesses.

CFOs have revised their own inflation and interest rate expectations upwards. They now expect inflation to be at 3.4% in a year's time, up from 3% in the last edition of the survey. They also expect Bank Rate to be 4% in a year's time, up from 3.75% now. This is in sharp contrast to expectations of a cut in rates in the earlier edition of the survey. Their assessment of the cost of credit for their own businesses has risen to a two-and-a-half-year high, reflecting tighter financing conditions.

Given the challenging backdrop, CFOs maintain a defensive strategy stance. They have sharpened their focus on cost reduction, which remains the top priority. By contrast, they are placing less emphasis on expansionary strategies such as introducing new products or services and expanding by acquisition.

With poor productivity in the UK another persistent concern of CFOs, this quarter we asked them to assess the different factors that may be limiting the UK's competitiveness. They rated domestic economic and political uncertainty as the top constraint. That seems to reflect a decade of quicker leadership turnovers, growing political fragmentation and near constant speculation over tax policy changes.

Regulation and taxation were rated as the second and third biggest constraints, followed by energy and labour costs. The top five factors ranked well above the trade relationship with Europe, workforce skills and shortages, and transport infrastructure as limitations to competitiveness.

In this edition of the survey, we also asked CFOs to rate where their businesses were in their AI adoption journeys. Two-thirds assess their firms to be around a quarter of the way towards realising the change they expect AI to ultimately deliver, suggesting the vast majority are still in early stages of adoption. Yet, they expect significant short-term business impacts. On balance, CFOs foresee a reduction in headcount and operating costs and an improvement in margins and revenue over the next twelve months due to the adoption of AI.

With the ongoing military and trade conflicts, geopolitics has emerged as the persistent business risk of this decade. Without a meaningful resolution to the Strait of Hormuz crisis in sight, CFOs are hunkering down for a period of elevated uncertainty, continued cost pressures and tighter financing conditions.