Construction Inflation Report

David Blackburn
The UK economy continues to be affected by the government’s decision to cut faster and further in order to tackle the budget deficit. Although the government is confident in its fiscal plan, concern is mounting regarding a slowing in the rate of economic growth, though recent figures released by the ONS show manufacturing output rose by 1.8% in May – up from a 1.6% drop in April.

Faithful+Gould UK Tender Price Index (TPI) forecast


20102011201220132014
April 2011 -3.0% +2.0% +3.0% +3.0% +3.0%
July 2011 -2.0% +2.0% +3.0% +3.0% +3.0%

The Faithful+Gould TPI forecasts follow the BCIS Industry standard forecasts, adjusted to reflect Faithful+Gould's market intelligence, and are based upon a year on year percentage change.

General Economic Outlook – UK

The UK economy continues to be affected by the government’s decision to cut faster and further in order to tackle the budget deficit. Although the government is confident in its fiscal plan, concern is mounting regarding a slowing in the rate of economic growth, though recent figures released by the ONS show manufacturing output rose by 1.8% in May – up from a 1.6% drop in April. Although on the face of it a good rebound, analysts’ view of the UK’s weak economy remain firm with current figures still significantly down on the previous quarter’s and the consensus being that the slowdown is set to continue. In November 2010 the IMF (International Monetary Fund) noted that the UK’s economy was on the mend. Forecasts for UK economic growth in Q2 stand at around +0.3%, influenced by April’s effect on economic activity resulting from extra public holidays, a later than usual Easter and good weather.

UK Consumer Price Index (CPI) inflation fell from 4.5% to 4.2% in June, driven mainly by poorer retail sales and a drop in prices for items such as clothing, footwear and audio visual equipment, though food costs continue to rise. On the one hand it is hoped that government cut backs and tax rises will lead to lower inflation by curbing consumer spending and therefore a levelling out in the general level of prices. Premature rises in interest rates could jeopardise this though. Previous concerns over a rise in interest rates have all but faded as the Bank of England keeps interest rates at their record low of 0.5% amidst fears of a slowdown in economic growth and prevailing low consumer confidence.

On the other hand the ECB (European Central Bank) opted to raise interest rates in the Eurozone to 1.5%, up from 1.25% in an attempt to cool inflation and allay concerns of overheating economies such as Germany’s. Concerns remain over whether this will affect the Eurozone debt crisis, particularly the borrowing costs of stricken countries such as Portugal and Greece. Fears over jobs are being reinforced by several big name retail closures in recent months and the highest levels of job cuts seen in the construction sector since January 2011 as consumers withheld from spending in May and June 2011. Despite this, the government is confident that its economic plans provide credibility, stability and confidence in the UK economy; firm figures for Q2 GDP will be released soon and will either confirm or disprove this.

Construction Outlook

The CPA has indicated construction output falling over the next 2 years, though picking up in 2013 with the aid of the commercial, energy and housing sectors. As previously reported, the decline in construction activity is in the most part a direct consequence of cuts to public expenditure. Public sector construction activity alone is set to drop by 24% by 2014, contributing to this drop in construction sector growth.

Output, Total New Work

Source: BCIS (Building Cost Information Service)

The BCIS expects output to rise through 2012-2013, driven mainly by increases in private sector construction as this sector seeks to replace lost work in the public sector. Rises of 50% in commercial sector activity are predicted, particularly in London and the South East with further rising activity in the energy and private housing sectors.

Commercial and civil sector output grew in June 2011 whilst house building recorded a drop in activity and demand remaining flat, with homeowners opting to develop their own homes rather than move; this being reflected in a surge in planning applications relating to domestic housing improvements. House prices on balance continue to fall though regionally, London continues to defy expectations with surveyors reporting rising house prices. Retail sector activity has also increased as retailers increase investment activity to improve their offering and increase market share in what is a highly competitive market.

Highly Competitive Bids

A turbulent construction sector is still proving highly competitive, with RICS surveys revealing the extent of the competitiveness of the construction sector currently by uncovering evidence of widespread below-cost bidding across the industry. Participants surveyed revealed that as much as up to 20% of tenders submitted during 2010/11 were priced at sub-economic levels, and in some cases up to 40% below cost.

Employment in the Construction Sector

Declining construction orders and lower output growth dented the construction industry’s confidence in June with job cuts at their highest since January 2011, this indicative of firms managing costs and displaying less optimism about future growth as they prepare for weaker output over the coming 12 months. This view is reiterated by Office of National Statistics (ONS) figures indicating that at 2.11 million workers, construction sector employment is now at its lowest point since Q3 2003.

M&E

Whilst generally following the same trend as building costs, both mechanical and electrical costs are being further affected by materials prices. Steel and copper are affecting mechanical prices, both of which are fluctuating considerably. Mechanical plant manufactured abroad is also tied into the exchange rate of the Euro. Marginally higher than building costs over the last 12 month, rises in mechanical and electrical prices have been fuelled by input costs, peaking at around 9% for a short period but averaging to around 4% on the year.

Materials

Following a marginal drop in the material price index between first and second quarter 2009, material prices are forecast to continue rising in 2011. Oil prices fell in July with a drop in Chinese imports – 11.5% lower than 12 months previously – and uncertainty surrounding the US economy’s strength both largely responsible for the decline. Compounding this are fears that demand will drop from Eurozone buyers such as Greece and Portugal as they continue to battle for their own economic salvation, though continued unrest in the Middle East could adversely affect oil prices during 2011.

The table below illustrates the current BCIS material price index forecast between January 2010 and March 2014 and highlights positive inflationary pressures throughout this period.

BCIS Materials Cost Index

Source: BCIS (Building Cost Information Service)

Key Material Cost Movements

Product
2nd Qrt 2010
2nd Qrt 2011
% Change from 2nd QRT 2010
Concrete Products



Cement 113.8
134.9
0.82%
Ready-mixed concrete 112.5 111.2 -1.17%
Pre-cast concrete products 116.8 120.8 3.31%
Clay Products


All Bricks 118.9 117.3 -1.36%
Timber and Joinery


Sawn wood 132.8 141.1 5.88%
Metal Products


Fabricated structural steel 110.3 133.8 17.56%
Electrical Products


Lighting equipment for buildings 109.7 105.4 -4.08%

This general upward trend in material prices has been in conflict with the general Tender Price Index and it can be seen that after 1Q 2010 the TPI started to increase which we suspect is due to a general settling of the market and additionally tender prices have dropped to a level that we believe could no longer be sustained. It remains to be seen however if this is a temporary blip or if the TPI will continue to show signs of growth.

Copper and Steelwork

Copper prices have also risen as demand outstrips production, with demand set to increase by 10% in 2011 alone. The supply deficit is contributing to the rise in copper prices with prices rising 30% in 2010, fuelled by the booming economies of China, India, Brazil and other emerging economies. Steelwork prices have seen the most significant increases over the last twelve months and from April 2010 to April 2011 prices increased in the order of 18%.

Construction Orders

New construction orders are expected to fall through 2011-2012. This reduction in new orders could force a double dip in the TPI, though forecasts expect that growth in construction will resume in 2013 following a sharp drop in 2011 and a levelling out in 2012.

Fukushima Daiichi Nuclear Crisis (Japan)

Following the Fukushima disaster the UK government recently gave its clearest indication that construction of the UK’s next generation of nuclear stations will proceed with Energy secretary Chris Huhne announcing 8 proposed sites for the next generation of nuclear reactors in the UK. This follows interim findings of the UK’s independent nuclear regulator which concluded that there is no reason for curtailing the operation of nuclear power plants or other facilities in the UK. As part of the National Policy Statement (NPS) on energy, The Nuclear Industry Association praised the government’s clear leadership and acknowledgement of nuclear power as a significant part of Britain’s energy future at a time when the UK must consider developments in future energy supply and demand. This turn of events has led developers to submit planning applications for proposed sites, an option previously unavailable until the energy NPS was published and an opportunity for these firms to benefit from UK’s demand for further, cleaner energy.

This contrasts with other European countries who have taken nuclear off their agendas entirely, though the Economist Intelligence Unit notes that those countries moving against nuclear power are exceptions to the rule. Generally and despite the scepticism some governments have displayed for nuclear power, enthusiasm for the next generation of nuclear generating plants has not been eroded.

BCIS – General Building Cost Index

Source: BCIS (Building Cost Information Service)

BCIS – All-in TPI

 

Source: BCIS (Building Cost Information Service)

Future Outlook

Despite the government’s confidence in its fiscal plan there remain concerns over the rate of economic growth in the UK. Lower inflation reported for June is positive news going forward though the Bank of England remains wary over a potential slowdown in economic growth and depressed consumer confidence.

Construction activity looks set to remain depressed until at least 2013 as public sector cuts continue to take hold though commercial, civil and retail activity remains buoyant for the foreseeable future and clarity has been brought to the UKs position on nuclear power generation.

Sales expectations remain positive in the housing sector, though price expectations are set to remain deeply negative. The construction industry is set to remain extremely competitive overall with tender pricing remaining cut-throat and materials prices set to continue affecting tenders and exposing contractors to pricing risks. Input costs look set to return to record levels though drops in the price of oil could feed through to lower costs in time.

Highlights

  • Concerns remain over the UKs economic outlook for 2011
  • Inflation falls to 4.2% in June
  • Construction activity set to fall off until 2013 though some sectors perform well
  • Construction sector employment at its lowest since 2003
  • Materials prices set to rise, though oil prices have recently dropped off

Competitor’s Views

The table below shows our competitor’s TPI forecasts and has seen a stable or slight downward movement in predictions.


Forecast date20102011201220132014
Faithful+Gould July 2011 -2.0% +2.0% +3.0% +3.0% +3.0%
BCIS July 2011 -2.4% +3.2% +3.1% +3.0% +3.0%
Gleeds April 2011
-2.3%
+1.4% +2.4% +3.0% +3.9%
Cyrill Sweett Q2 2011 0% +1.0% +2.5% +3.5% 3.75%
Gardiner & Theobald Q2 2011 -2.5% +1.5% +3.0% +3.5% +3.5%
Turner & Townsend Q2 2011 +2.5% +3.0% +3.5% N/A N/A