Exchange rate factors in the
UK Construction Industry
Posted March 2010
With a pause in quantitative easing in the UK, a general election just around the corner and the eurozone confidence shaken by the debts of certain member countries, what if the UK pound were to return to the historic levels of 2002-2007?
Richard Anderson, our UK Cost Intelligence Manager, comments on how the varying exchange rate and other factors might affect the UK construction industry.
Fiscal policy and construction
Prior to the beginning of 2008 the British pound looked reassuringly stable against the euro. However, the loss of confidence arising from the UK's exposure to the financial effects of the credit crunch and subsequent dampening of economic activity was far more severe than the level of confidence perceived in the eurozone.
As the Bank of England reduced interest rates further and faster than those in the eurozone, exchange rates reacted predictably with sterling dropping by 40% against the euro over a 12 month period.
As usual, due to the nature of capital projects, the construction industry was affected more severely than other areas of the economy. House building was first to be affected, with mortgages drying up overnight, followed by most of the other commercial development sectors.
Exchange rate history
Source: http://www.dollars2pounds.com
Effect of quantitative easing
We may never know if quantitative easing has actually saved the economy from a credit-led depression, but it is hoped that the boost in money supply will encourage spending and help credit growth.
The effect on the construction economy has been negligible to date as, with the spectre of sub-prime mortgages and other recent poor property lending decisions in mind, banks have been reluctant to use the money generated through the easing policy to increase lending either through domestic mortgages or funding commercial projects.
The general election, to be held by 3rd June 2010, without a doubt will result in government public spending cuts, but to what extent we will have to wait and see. One sure result is that the construction industry will not emerge unscathed, with future projects possibly delayed or shelved. However, provided a ‘hung' parliament does not occur, either party's post election agenda should bring more certainty to the economy.
Eurozone: trade and migration
The troubled and indebted economies of Portugal, Ireland, Greece and Spain show little hope for a quick turn around. This is contributing to a downward pressure on the euro, resulting in the possibility of a slowing in recovery within the eurozone.
The combination of the positive benefits of quantitive easing and greater certainty post-election in the UK, and the negative effect of the struggling economies within the eurozone, could lead to greater strengthening of sterling against the euro this summer.
The UK sources £12 billion of construction materials from abroad whilst exporting £6 billion, a net balance of £6 billion. As a significant proportion of this trade is with the eurozone countries, the euro exchange rate is significant to UK construction costs. With an increase in the exchange rate, sourcing building components from the eurozone will favour the purchaser. Whilst some major European suppliers with UK divisions may be at risk when internally trading as they tend to fix exchange rates for set periods of time, most continental suppliers will only fix exchange rates once orders have been secured.
Since the downturn there has been a marked exodus of skilled foreign labour back to Eastern Bloc countries due to relative wages being of greater value as a result of the falling pound. This has given rise to labour shortages in the UK, but in agriculture rather than the construction industry where the slowdown has been the catalyst to return.
Signs of an upturn?
Despite all the doom and gloom, latest figures show that house prices are inching back up again and the house builders are gearing up to increase the new housing stock. In the past this has been a good indicator of the first signs of recovery and a positive sign for the UK construction industry. Is this really the start of "green shoots"?
When the euro exchange rate fell in 2008-9, apart from an initial ‘blip', construction costs did not rise to compensate for the weakened UK buying power. This suggests that the basic laws of supply and demand within the construction supply chain have a considerably greater effect on costs than the effect of exchange rates.
Looking forward, a rise in the exchange rate would contribute to further falls in construction costs as it is likely that cuts in public capital construction projects will not be compensated by improvement in the commercial construction sector. This will cause the sector to lag behind any improvement in the general economy.