Firms across the UK are holding back from fully passing on rising costs to customers despite soaring inflation.
The rise in cost inflation in May was driven by the service sector, which saw costs rise at a record rate, as businesses continued to grapple with higher energy bills and wage costs amid fierce competition for staff, according to the latest UK Sector Tracker by Lloyds (LLOY.L).
For the second month, cost inflation was highest among tourism and recreation firms, which includes pubs, hotels, restaurants, and leisure facilities.
“High inflation is dampening consumer demand and increasingly weighing on the ability of companies to pass on rising costs. Our latest UK Sector Tracker shows service businesses having their margins squeezed more tightly than manufacturers,” Jeavon Lolay, head of economics and market insight at Lloyds Bank Commercial Banking, said.
“Recently, the gap between input costs and prices charged was widest for manufacturers, primarily reflecting the impact of the pandemic on international supply chains and stronger relative consumer demand for goods than services.
"The reversal of this trend evidences both changing spending habits and that service providers are becoming more concerned about the potential fragility of customer demand. However, the broadening of price pressures across the economy also points to the risk of more persistent inflation and therefore more policy tightening by the Bank of England.
“All eyes will remain fixed on forthcoming UK activity and inflation data to assess the potential scale, pace and timing of further rate increases from the Bank of England.”
The report also shows that the number of UK sectors reporting a fall in output doubled in May to six out of 14, compared to three in April, as inflation continued to drive down demand for goods and services.
This was the largest number reporting a fall in output since February 2021. However, eight sectors still saw output growth, down from 11 in April.
The slowdown was driven by falling demand, as consumers and businesses reined in spending amid record levels of inflation.
Eight out of the 14 sectors monitored experienced a fall in new orders in May, the highest number since January 2021.
Household product manufacturers registered the fastest decline in output of all 14 sectors monitored by the Tracker in May. Food and drink producers saw output contract for the first time since July 2021 as new order levels also fell.
“Continued input cost inflation means it’s more important than ever for businesses to ensure they have a healthy cashflow,” Scott Barton, managing director, corporate and institutional coverage at Lloyds Bank Commercial Banking, said.
“With inflation at its highest point in 30 years, firms may face larger up-front operational costs than they have before, and a larger working capital requirement.
“Any excess funds tied up in unused inventory, unsold stock or elements like unpaid invoices are funds that can’t be used to seize on new opportunities, wherever they arise. Optimising their finances will help ensure firms have the maximum possible liquidity to help them be flexible in their operations and trading and to continue where possible to pursue their growth objectives,” he added.
The report said it expects businesses to focus on balancing their levels of stocks, and ensure they have sufficient raw materials ahead of any further price rises, but avoid having too much working capital tied up, restricting investments elsewhere.