RBS: Inventories running low Print
Written by Gary Howes   
Thursday, 09 July 2009 14:02
Comment from Stephen Boyle, Head of RBS (LON:RBS) Group Economics on whether recent green shoots were in fact a 'dead cat bounce':

"Firms hold inventories as a buffer to help cope with unexpected changes in demand. So in the early stages of a downturn it’s normal for firms to see their inventories rise, as demand falls off more quickly than they expect. But in a full blown recession the fall off in demand lasts longer than during “normal” fluctuations and stock levels quickly reach uncomfortably
high levels.

This ultimately contributes to the depth and length of the downturn in the wider economy, because in order to clear bloated stockrooms, firms have to cut production by more than they otherwise would have done simply to align production with a lower level of demand.

This leads to more job losses and reductions in demand across the economy.

In the UK the de-stocking process has been in full flow over the past six months, as businesses were caught off guard by the extent of the slowdown at home and abroad. Since mid-2008 firms have been running down stocks at a breakneck pace – far faster than in previous downturns.

The decline is even more dramatic when we consider the technological advances and shift in industrial structure which has occurred in recent decades. “Just in time” management and better IT has allowed firms to keep production much more closely aligned with market conditions, meaning firms have been able to hold fewer inventories over time.

Similarly, the move that we’ve seen towards a more service-based economy means that there is less scope for inventory build up across the economy (as service firms tend to hold less stock).

Could we see a dead cat bounce?


Surveys indicate that a significant proportion of firms still view their inventories as being more than adequate (chart 3).

Nevertheless, the savage nature of recent cutbacks suggest that we may be about to see a pause in the inventory liquidation process.

This by itself could be sufficient to allow the UK to post a quarter or two of positive growth. For example, if de-stocking stopped in Q2 this would boost the quarterly growth rate by more than a percentage point. Though welcome,
this would not necessarily herald the start of a sustained recovery and instead prove to be a “dead cat bounce".

Ultimately, production will only be permanently ramped-up if it is supported by final demand. The omens on that front are not good.

Consumers are under pressure from rising unemployment and slower wage growth. Pressure to bolster finances remains intense amid falling asset prices and still high debt levels. Similarly, firms have little appetite for capital goods, as utilisation rates of plant and machinery remain at low levels. In other words, a sustained recovery may still be some way off."
 
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