Construction Inflation Report

David Blackburn
Hopes of an economic recovery have been hit hard by the UK’s own economic performance, albeit correlated to events unfolding in the Eurozone crisis. Figures revealed by the Office for National Statistics (ONS) in May 2012 showed the UK economy shrank in the first quarter of 2012 by 0.3%, driven mainly by weakness in construction output.

Faithful+Gould UK Tender Price Index (TPI) forecast


2012201320142015
Feb 2012 +0.0% +1.0% +2.0% +4.0%
July 2012 -1.0% 0.0% +1.5% +2.5%

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.

Highlights

  • UK GDP growth confirms the economy has again entered into recession.

  • Events unfolding in the Eurozone continue to affect all aspects of the economy, from consumer confidence to compounding investor worries.

  • Construction output and new orders ease, as do input prices following lower global demand.

  • Activity in the construction industry remains bleak as public sector cuts begin to take their toll and investor and developer confidence remains subdued against the backdrop of a faltering economy and impending Eurozone crisis.

General economic outlook

Hopes of an economic recovery have been hit hard by the UK’s own economic performance, albeit correlated to events unfolding in the Eurozone crisis. Figures revealed by the Office for National Statistics (ONS) in May 2012 showed the UK economy shrank in the first quarter of 2012 by 0.3%, driven mainly by weakness in construction output. Along with a fall in GDP in the last quarter of 2011 of 0.3% (larger than previous ONS estimates) this has prompted the first double dip recession since the 1970’s.

GDP Forecasts


 

Source: ONS, OBR, Bank of England, HM Treasury, 2012, Forecast for the UK economy; a comparison of independent forecasts, March

However the National Institute for Economic and Social Research (NIESR) has conversely suggested that the UK economy is not in recession, reporting growth of 0.1% in 1Q2012. Despite this, the message conveyed by both the ONS and NIESR is that economic activity in the UK will remain subdued.

The Bank of England have  programmed to release a  further £50bn of ‘electronic’ money into the economy through  Quantitative Easing. The impact of the QE programme stimulating the economy remains difficult to measure in economic terms and has a divided opinion amongst the leading financial analysts.

The UK LIBOR rate has fallen during 2012 providing cheaper borrowing to businesses and acting as a potential stimulus to growth, however confidence in the LIBOR rate is has been undermined following alleged malpractice in manipulating the rates.

12 Month LIBOR Rate


Source: British Bankers' Association (BBA)

 

The UK’s deficit reduction programme continues to receive criticism with critics arguing that monetary policy alone will not fuel the UK’s recovery but rather growth and job creation, particularly against the backdrop of other strong European economies such as Germany which continue to perform well amidst the turbulent Eurozone.

In light of this, the UK is also inextricably linked to the Eurozone with prospects for UK growth muted by the UK’s reliance on the Eurozone through exports and business investment – particularly given the strength of the pound against the euro – and employment – with around 3.5 million jobs in the UK linked to European Union exports. UK employment remains precarious not least because of ties to the Eurozone but also due to continuing public sector cuts.

The government has voiced concern over the fragility of the Eurozone and until events are resolved, British businesses will continue to be held back by undermined consumer and business confidence. Recent manufacturing activity reported by the ONS has shown surprise falls of 0.7% for April –9% below its January 2008 peak – contrasting with a rise in March and dashing hopes of an economic recovery that has already been hit by an extra bank holiday in June.

Services on the other hand are experiencing better fortunes, with 50% of respondents to a BDO survey reporting positive prospects for service sector activity despite input and output prices tightening as firms continue to operate in an increasingly competitive yet uncertain economic environment.

The British Chambers of Commerce (BCC) has suggested more forceful domestic deregulation, a moratorium on European regulation hindering UK businesses, improved access to finance and clearer strategies in particular areas of construction such as infrastructure where there are opportunities to kick-start the void left by public sector capital investment spending cuts, in order to forge a bolder, more enterprise friendly government that enables firms to grow in the long term whilst abiding by its deficit reduction programme.

Future estimates for UK growth are pessimistic, with the BCC revising its own forecast down from 0.6% to 0.1% for 2012 and growth of 1.9% and 2.3% for 2013 and 2014 respectively. The Office for Budgetary Responsibility (OBR) forecasts growth slightly higher at 0.8% for 2012 though doesn’t rule out further falls. The Bank of England forecasts UK GDP growth to be affected by the Diamond Jubilee and Olympics, remaining subdued until household consumption and real incomes increase. Inflation is beginning to drop away from recently high levels currently standing at 2.8% in May. This could aid growth in the latter part of 2012 and beyond as households begin to experience falling living costs. Again, a tight Euro area and deficit reduction will continue to dampen the rate of growth in the economy.

There is a general attitude amongst firms, contrary to published statistics, that opportunities for growth in the economy do exist. If the government can instil confidence by promoting investment in infrastructure to offset cuts in public spending and continue promoting policies that promote job creation and enterprise, whilst remaining committed to implementing spending cuts, it is felt growth will return though over a longer period – albeit dependent on how events unfold in the Eurozone.

Employment prospects in 2012

Manpower Group’s quarterly employment outlook survey suggests employment prospects remain positive, with firms still hiring albeit at their slowest pace since December 2011 and at lower levels in some industries than a year earlier, with the finance and business services and utilities sectors continuing to hire at the fastest rates.

Regional discrepancies continue to exist with prospects brighter in the South when compared with Wales, the North of England and Scotland. Perhaps not surprisingly it is larger firms that are more optimistic over employment prospects with smaller firms being more cautious.

Small rises in permanent staff placements have been exceeded by larger increases in flexible staff and self-employed, which along with the decreased pace of hiring suggests that across the board, firms are not entirely comfortable hiring against the backdrop of events in the Eurozone and domestically.

The ONS confirms this, reporting quarterly increases in employment of 0.2% between 4Q2011 and 1Q2012, almost entirely due to an increase in the number of part-time workers.

The Chartered Institute of Personnel and Development (CIPD) maintains a positive view on the immediate jobs outlook, though perhaps not surprisingly has tempered this by warning that domestic and Eurozone prospects may lead to employer’s reassessing staffing levels throughout 2012.

Construction Activity & Inflation BCIS – All-in TPI

BCIS – All-in TPI 

Source: Building Cost Information Service (BCIS)

 

As previously alluded, the fall in GDP can be attributed to the slowdown in construction output throughout May. Although the ONS had reported an increase in construction new orders of 4.6% in the first quarter 2012, the pace of expansion has been the slowest for three months. The Chartered Institute of Purchasing & Supply (CIPS) Purchasing Managers’ Index fell in May, reflecting the subdued rate of expansion in the construction industry owing to weakened demand for new large civil engineering schemes.

Driving new orders, quarter on quarter private industrial and private commercial new work have helped keep construction growth at 4.6% more than 4Q2011 with increases of 57.9% and 27.8% respectively.

Despite year on year infrastructure orders shooting up by nearly 60% in 1Q2012, the rate of growth fell 13.6% between 4Q2011 and 1Q2012. Private new housing orders also remain at low levels, falling 10.7% with firms citing dampened economic confidence and weaker demand as the reasons behind slowing construction activity in these areas.

The Homes and Communities Agency (HCA) also showed the number of affordable housing starts falling by two-thirds to just 15,698 for last year following actions taken by the government to cut affordable housing budgets and changes to affordable housing funding model. Despite this the HCA and government has confirmed that it’s still on target to deliver 170,000 new homes by 2015, which may include the possibility of forward spending on affordable housing to ensure the targeted number of homes are built.

Uncertainty surrounding the Community Infrastructure Levy (CIL) may also potentially delay projects as the government’s decision to address the issue of how the CIL is applied is delayed until October 2012, leading developers to place projects on hold because of the financial risk, until the outcome is known.

Despite varied activity, new orders remain 3.6% lower than a year earlier. New business growth and tender activity also remains subdued with new orders generally remaining at low levels, substantiating the consensus that subdued or even negative growth may continue to pervade the construction industry throughout 2012. Higher input costs driven by fuel and steel prices are expected to drop slightly as weakened economic pressures present opportunities for price negotiations with suppliers.

Construction output has also fared badly, with the total volume of construction output falling 4.8% between 4Q2011 and 1Q2012 driven in large part by decreases in infrastructure output of 15.9% and also down by 3.7% compared with the same period a year earlier. April’s output was 8.5% lower than at the same point a year previously, again compounding miserable UK GDP contraction of 0.3%.

Construction sector employment remains somewhat positive, with the slowdown in construction sector activity potentially presenting issues should the slowdown continue. PricewaterhouseCoopers (PwC) previous insolvency outlook for construction has not abated, with the financial services firm suggesting that the construction industry is likely to see more high profile casualties in 2012 after the industry lost around 5,000 firms in the last two years. As before, the fragility of the UK’s economy and issues surrounding the Eurozone only serve to compound the uncertainty surrounding workloads and the ability of firms to continue trading.

BCIS – General Building Cost Index

Source: Building Cost Information Service (BCIS)

 

The Building Cost Index continued last year’s trend by rising slightly in 1Q2012 owing to rising input prices, though oil prices have hit a 17-month low of around $100 a barrel as Chinese demand sets to weaken with Eurozone woes compounding this. This may have positive consequences for manufacturing, transport and site costs throughout 2012. Copper prices are also down as investor worries continue to mount due to global growth prospects in Europe, China’s slowdown and the US economy’s recovery. Declining input prices may lead to construction firms pricing more competitively in the hope of winning new work, though this may end up hurting suppliers as their margins in turn are squeezed.

Steel prices face a similar fate as steel company share prices dropped in mid-June owing to investor worries over falling demand, though this may pick up towards the tail end of 2012 albeit at a slower pace than previously estimated, as inventory levels align with demand following anticipated steel production cuts.

Steel production is dominated by Asia which is producing approx 65% of the world steel supply.

Crude Steel Output

Crude Steel Output 
Source: World Steel Association

Labour costs remain subdued as wages remained frozen or increased only slightly at the beginning of 2012 from a year earlier. Negotiations are continuing amongst trades such as plumbers and building and civil engineering operatives which may lead to rising wage rates towards the end of the year.

Future outlook

  • Events in the Eurozone continue to affect domestic growth through subdued consumer and investor confidence, with many continuing to criticise the deficit reduction programme.
  • Continued lack of available finance and a shortfall in demand continue to dampen activity in the construction sector.
  • 2012 looks set to remain a difficult year for the construction industry amidst predominantly negative surveys and views on construction output, with activity not picking up until 2013/14.
  • Tender prices will decrease as falling workloads place negative pressure on contractor pricing.
  • Employment forecasts remain cautious as uncertainty continues to surround anticipated workloads into 2012.
  • Major forthcoming infrastructure projects such as HS2, Crossrail and the UK nuclear programme will stimulate construction growth.
  • If the Eurozone debt crisis can be resolved then confidence is likely to return into the economies rewarding them with growth that will filter through to their construction industries.

Competitor’s views

The table below shows our competitor’s TPI forecasts and has seen a downward movement in predictions over the last quarter.


Forecast date201220132014201520162017
Faithful+Gould July 2012 -1.0% +0.0% +1.5% +2.5% +3.0% 3.0%
BCIS June 2012 -0.0% +2.2% +3.1% +3.8% +4.9% N/A
Gleeds Mar 2012 +0.2%
+1.2% +2.5% +3.7% N/A
N/A
Cyrill Sweett Q1 2012 -0.5% +1.5% +2.5% +3.5% +4.0% N/A
Gardiner&Theobald Q1 2012 0.0% +1.5% +2.0% +3.0% N/A
N/A
EC Harris May 2012 -3.3% -0.9% +2.5% +4.0% +3.0% +3.5%