Macro Economics

Two consecutive quarters of decline in 2020 were followed by a 16% quarter-on-quarter rise in GDP in Q3. However, in light of the Government lockdown restrictions in Q4 2020, it’s highly probable that the UK will experience a double-dip recession in 2021.

On an annual basis, 2020 will record the biggest drops in national output since 1709. The bounce in Q3 2020 prompted some to hope that the UK would recover much of the lost ground by the year’s end. However, this proved to be a false dawn. GDP growth in the third quarter of 2020 proved to be fleeting and the UK economy now looks set to end 2020 more than 10% smaller than it was in the final few months of 2019.

In Q3 2020, although output in the services, production and construction sectors all increased by record amounts, output remained below Q4 2019 levels – before the impact of the COVID-19 pandemic was seen. Tougher restrictions introduced towards the end of 2020 and into the New Year are likely to mean that instead of a boom in 2021, the economy is destined for a double-dip recession.

However, Oxford Economics has suggested that this is not really a recession in the normal sense of the word but rather an artificial hibernation by diktat of the government. Once constraints are removed, the economy will recover quickly as pent-up demand is released, but the latest national restrictions will have pushed back the recovery from the first to the second quarter of 2021. Economists also anticipate that the second leg of the double-dip recession will not be as severe as the first. Manufacturing and construction have stayed open throughout the latest lockdown and many firms will have been better prepared and able to adapt their business models in response to the latest restrictions. Several forecasting bodies have yet to publish updated Q1 2021 GDP forecasts but those that have envision a contraction in GDP of around 1.5% in Q1 2021.

According to the IHS Markit/CIPS UK PMI readings, UK construction activity has grown month-on-month since June 2020. The most recent survey (December 2020) reported strong business optimism as both output and new orders increased for a seventh consecutive month. Although growth is slowing, overall output levels are encouraging and show strong underlying demand. The sector is extending its robust recovery but it’s clear that the housing sector is currently the biggest driver of growth. However, Tim Moore, economics director at IHS Markit said that demand is expected to broaden out beyond residential projects over the next 12 months, led by infrastructure spending and a small potential rebound in new commercial work from the current depressed levels.

Other macro indicators, namely the CPI and the RPI, indicate that the UK is in a sustained low-inflation environment. Consumer prices rose at an annual rate of 0.6% in December 2020 – well below the Bank of England’s 2% target – whilst retail prices over the last 12 months rose by 1.2%. UK inflation has been falling gradually for the past two years but it has dropped more sharply during the pandemic. Although price conscious consumers, excess capacity, limited earnings and curtailed economic activity are likely to limit inflation in the near term, the expectation is that this trend will reverse in the coming months and inflation will gradually edge back up. A comparison of independent forecasts for the UK economy published by HM Treasury in December 2020 showed that UK CPI (on average) is expected to grow by 1.9% whilst the RPI is forecast to grow 2.6% in 2021^[1]. However, these figures are likely to be moderated in light of the latest lockdown restrictions.

In a recent in parliament statement, chancellor Rishi Sunak said he expected the economy to get worse before it gets better, noting that so far the downturn has cost around 800,000 jobs. Public finances have been badly damaged as a result of the Government's £280bn support package for business and jobs and at some point, public finances will need to be put back onto a sustainable footing. The Government’s unprecedented levels of borrowing to keep the economy afloat comes at a cost. The OBR predicts a £394bn Budget deficit this fiscal year – seven times larger than the 2019-20 deficit. Accordingly, the chancellor envisions future Budget cutbacks and additional taxes (when the UK’s recovery is more advanced).

The central bank has so far resisted further cuts to the base interest rate which remains at a record low of 0.1%. The Bank of England (BoE) has prepared the groundwork for negative interest rates and BoE policymakers suggest that cutting interest rates below zero could be good for growth and would help boost inflation back towards target levels. However, no decision will be made until the Monetary Policy Committee meet in February after it has had a chance to look at the technical feasibility of negative rates.

UK unemployment rose steadily in the second half of 2020. In the three-month period between September and November, the rate reached 5%. The extension of the Job Retention Scheme will provide a lifeline for many jobs over the winter period, but it remains to be seen what happens after it ends at the end of April. Some economists expect a steady trickle, rather than a tsunami, of job losses over the next few months but the OBR estimated, before the tougher restrictions were introduced in January, that the jobless rate would hit 7.5% by mid-2021 (up from 4% before the pandemic struck). Regardless, while the UK unemployment figures could be much worse, the labour market remains fragile and uncertain.

Despite an initial optimistic uptick from a Brexit deal, the UK economy will be starting 2021 on the back foot. However, a durable recovery is on the horizon providing that the UK’s vaccination rollout programme is successful and can enable the relatively rapid removal of lockdown restrictions.

[1]https://www.gov.uk/government/statistics/forecasts-for-the-uk-economy-december-2020

CONSTRUCTION OUTPUT

UK construction output (‘All Work’) has staged a remarkably strong recovery since the peak of the first wave of the virus in April 2020. Output has now grown for seven consecutive months and in November 2020, construction output was just 1.4% lower than it was in the same month in 2019. In fact, output levels in November 2020 were actually 0.6% higher than they were in February 2020 – just before the introduction of the first national lockdown.

For new work, infrastructure was the only sector to see higher output levels in November 2020 compared to the same month in the previous year (+10.6%). The industry has got stuck into a series of major public infrastructure programmes helping to drive output growth. Although new work output for all other sub-sectors was down year-on-year, all repair and maintenance sub-sectors have experienced output growth. Repair and maintenance work has served as relatively consistent source of fuel for recovery since June and this is being helped by the green buildings/net-zero carbon agendas.

Private sector housebuilding has been another strong area. Output was still marginally down year-on-year in November 2020 but the sub-sector is once again contributing in excess of £3bn of new work to the £14bn UK construction sector. There was another sharp rise in housebuilding activity in December according IHS Markit’s PMI survey. Higher demand for private new housing has helped underpin the recovery in output and also led to a rise in employment numbers.

Output for private commercial new work and public new housing in November 2020 were both significantly lower than they were compared to one year ago (-15% and -29% respectively). It’s been very difficult to decide on a long-term strategy for commercial office occupation post COVID-19. Commercial workloads are likely to remain suppressed in 2021 as clients take time to determine what the ‘office of the future’ may look like. However, new, high quality office products may still go ahead as these offer better sustainability as well as health and wellbeing features. If businesses do decide to reduce their footprints, this will create a substantial number of sub-let opportunities - a trend that has already begun to pick up pace. Demand for larger, campus-style office developments may subside, but landlords are likely to consider adapting, refreshing or even repurposing their existing stock, leading to a greater demand for refurbishment projects.

Output in the retail, hospitality and arts, heritage and culture sectors is also expected to be curbed in 2021. Under the current lockdown restrictions there is significant uncertainty over leisure activities and little income or investment is expected in the short-term. To help counterbalance weakness in these sectors in 2021, output growth will be driven by a handful of key sectors including healthcare, senior living, logistics and infrastructure. There has been an abundance of planning applications for developments within these sectors and the pipeline looks strong. The residential sector is also expected to remain buoyant with a strong push to create affordable housing and BTR schemes, but some of our TPI respondents said they expected a slowing in the private residential market this year.

With sites being told they can stay open, contractors and developers appear to be managing the risks fairly well at the present time but with the more infectious COVID-19 variant spreading across the UK, site productivity levels may take a hit if work has to be suspended. Also impacting site productivity and project delivery is the fact that, despite calls from industry bodies such as RIBA, most construction workers do not have ‘key worker’ status. Consequently, a significant proportion of workers will struggle to attend site and manage their homeschooling and childcare commitments, and this could have an impact on output in Q1 2021.

Despite the impressive V-shaped recovery in Q3 2020, we estimate that construction output for the year as a whole will be around 15% lower than it was in the previous year (2019). Looking further ahead, the Construction Products Association’s (CPA) winter scenarios forecast indicates that output will grow by 14% in 2021 and a further 4.9% in 2022. However, the CPA, which predicts an overall ‘W’ shaped economic recession and recovery, warns that output could slump later on in 2021 if there is a sharp rise in unemployment once the furlough and self-employment support schemes end in April. It also notes that the delivery of major infrastructure projects will be crucial to output growth in 2021.

NEW ORDERS

New orders experienced a spectacular recovery in Q3 2020 (the latest period for which data is available). New orders (All New Work) rose by 89% in Q3 compared to the previous quarter. In fact, new order values in Q3 were marginally higher than they were in the same quarter in 2019 – 0.6% or £70m higher.

The only sector not to see quarter-on-quarter growth in Q3 2020 was public new housing (-2%). All other sectors helped to drive new order growth but none more so than the private industrial sector where new orders grew by 140% in Q3. The increased need for logistics, distribution and warehousing facilities became very apparent in 2020.

On an annual basis, three sectors received fewer new orders in Q3 2020 – public new work (-4%), private housing (-14%) and once again, public new housing (-22%). Interestingly, the private commercial sector saw the highest annual growth rate in new orders, with new order values increasing by 16% year-on-year. The latest PMI survey (December 2020) also shows that the commercial construction activity is still growing albeit at the slowest rate since the recovery began in June. It remains to be seen whether there will be a sustained rebound in commercial work into 2021. TPI survey respondents indicated that a number of office occupiers are reducing, or are at least talking about reducing, the amount of space they occupy to pursue more flexible working policies. However, as noted above, there could be a burst of activity in the short term as space is repurposed and prepared for sub-tenants.

There is evidence from IHS Markit that the strong new order growth in Q3 continued into Q4 2020. The IHS Markit report covering the month of December revealed improving client demand and a boost for workloads from new wins on projects deferred at the start of the COVID-19 pandemic. Growth in order books remained close to November’s six-year high, when new orders increased at the fastest rate since October 2014. However, there is a question mark over how the latest national lockdown will affect the speed at which future projects are brought forward and how they will impact decisions on private investment.

G&T TPI survey respondents believe there are still a reasonable number of new project opportunities in the market but there is a lack of long-term commitments in relation to certain sectors (namely office and commercial) and this may impact new orders in 2021. Despite the recent uncertainties brought by the pandemic and Brexit, there was an abundance of planning applications for developments in several sectors in 2020 which will help keep workloads stable in 2021.