Q1 2022

Our Forecasts

2201 Q1 2022 TPI Dashboard Arrows Macro

Ever since inflation reared its ugly head, much has been written about the transitory or structural inflationary view in an attempt to predict price movement. Some have likened inflation to toothpaste insomuch that once it’s out, it’s hard to get back in the tube. A number of economists are now leaning towards the view that we’ve entered a more structural inflationary period and that inflation is here to stay for the short to medium term. However, simple maths tells us that from the spring, some price rises will drop out of the annual headline inflation data. This will leave us with higher price levels, but a much lower inflation rate.

Seldom does inflation get as much attention as it has done over the past year or so. The news cycle continues to be awash with supply chain problems driving inflationary pressures and the impact it is having on a global scale. The UK construction has seen its fair share of inflationary rises in 2021 with material prices rising at record rates and wages showing potential signs of following suit. Higher logistics, shipping, fuel and energy costs have added to the growing wall of input cost pressures, but we suspect some of these will ease throughout 2022.

Inflation is a key measure of how the economy is doing. For the first time in a decade, headline inflation has exceeded 5%, prompting the first interest rate rise in three years. With inflation so high (and expected to peak higher in the spring due to rising energy prices), the importance of productivity and efficiency becomes elevated as businesses carefully consider their cost base. The Bank of England’s main concern is not so much what inflation does in the coming months, but whether it triggers longer-term inflationary pressures, namely wages in a tightening labour market.

The current material price inflation issues are far easier to address than the labour-driven inflationary issues. We anticipate material price inflation normalising in the short to medium term as supply and demand meet and production output returns to capacity, but the key drivers of labour cost inflation will not be as easily resolved. The ongoing skills shortage is led by demographics and societal perceptions which are far more difficult to change. Adopting new technologies and practices may help address our labour shortfalls, but these innovations will likely lag the squeeze on labour resource which is an immediate and mounting pressure.

Against this backdrop, we expect that the UK construction sector will remain in a continued inflationary environment all the way to 2025 as various input cost rises weigh in on tender pricing and construction costs. We anticipate that the greatest inflationary rises over this period will likely be experienced this year.

Our latest set of forecasts sees our previous estimates for tender price inflation rise across nearly all regions, with only Northern Ireland remaining unchanged at 4% annual inflation. This has pushed up our UK weighted average inflationary forecast to 2.5% this year (previously 2%). Much of the inflation being forecast for 2022 is likely to be seen in the first half of the year (ie a front-loading of inflation) due to the confluence of numerous input cost pressures. Thereafter, we anticipate that demand side factors contributing to higher material price inflation will fade and supply side inflation factors will begin to normalise, putting less upward pressure on material prices. Supply chain pressures are showing signs of improvement and, pending no further supply chain shocks, this is expected to continue. The anticipation of UK plc returning to normal working patterns and dealing with COVID without significant disruption have helped this forecast. Last year’s surge in energy prices is also widely expected to unwind as the year progresses but will likely remain above historic levels.

The above will take some of the heat out of headline inflation but as we explore in this report, inflationary labour pressures will come to the fore and help keep annual tender price inflation at an average rate of 2% between 2023 to 2025.

All forecasts in this report take account of all sectors and project sizes as a statistical average, indicating an overall trend in pricing levels. It should be remembered that individual projects may experience tender pricing above or below the published average rate, reflecting the project specific components and conditions.

The Economy

Although the impact of the Omicron wave of COVID-19 infections is expected to be modest, when official GDP figures are published for December and January, they will likely show a contracting level of economic output.

The short dip creates a weak starting point for expansion in 2022 and so economists expect to see a rebound in GDP growth thereafter and a surpassing of pre-pandemic GDP levels in the first half of the year. The bigger impediment to growth in 2022 is likely to be the rising cost of living, spurred by rampant inflation. Real incomes will also be affected by April’s National Insurance tax rise which will play a part in capping consumer spending growth in 2022.

Recent surveys by Deloitte indicate that British corporate leaders, while concerned about labour shortages, are optimistic about the outlook for 2022. UK companies are looking past Omicron and plan to expand operations and increase investment this year with the expectation of strong UK and global demand for goods and services. Supply chain disruption and inflationary pressures are key areas of concern, but labour shortages were seen as the greatest risk to businesses and therefore economic growth. Grappling with issues in recruiting and retaining staff, businesses have said they will have to diversify their hiring streams in the face of ongoing skill shortages.

In the fourth quarter of 2021, spiralling inflation prompted a rise in interest rates by the Bank of England. The UK consumer price index jumped to 5.4% in December largely due to persistent increases in energy prices and is still expected to peak higher this year. In this environment of elevated consumer price inflation, further interest rate rises are being priced in the market this year in an attempt to bring inflation back to the 2% target over the medium term. However, the BoE’s monetary policy committee has a difficult path to tread as it trades off higher inflation with potential slower growth headwinds from the resumption of global lockdown restrictions. New Brexit import controls coming into effect at the start of 2022 will further contribute to lasting price pressures, which risk feeding into longer term inflation expectations.

The BoE is acutely aware that setting interest rates with the sole aim of controlling inflation runs the risk of undermining economic growth. This is, in part, why the BoE has until recently been less willing to act on inflation, as a series of interest rate hikes could derail the economic recovery. The hiking cycle has kicked off, but it remains to be seen how far rate rises will go to bring inflation back down to target in the medium term.

No one has a crystal ball to predict what is in store for the economy but there are some key themes we expect to carry over from the end of 2021 into this year. On top of rising interest rates and high inflation (that will hopefully stabilise), a tight labour market and squeezed incomes impacting spending and consumption will play a key role in how 2022 unwinds. Economists also predict continued issues with supply chains. Despite these pressures, forecasters such as the OECD expect UK economic growth will be 4.6% in 2022, noting that previous waves of the pandemic have shown a successively smaller hit to GDP compared with the first phase of the emergency, when the economy collapsed by a fifth in a single quarter in spring 2020.

Growth estimates vary wildly but almost all agree that the UK is losing momentum. The boost from reopenings has faded, labour shortages and supply bottlenecks are biting and demand shows signs of moderating.

Construction Output and New Orders

After several weak months, new data from the ONS shows construction output recovering. Following a fall of 1.7% in October 2021, output rebounded by 3.5% in November – the fastest monthly rise since March 2021. The increase in monthly output was driven solely by a 5.7% increase in new work, while repair and maintenance saw a slight decline (-0.2%). Output growth was supported by strong new private housing activity (+5.5%), but it was the infrastructure sector that experienced the largest monthly rise at 11.4%.

Easing supply chain bottlenecks, fewer issues in sourcing products together with mild and dry weather helped builders to press on with new work and ramp up production in November. The latest figures mean that construction output is now 1.3% above its pre-coronavirus level. Also helping to weather this year’s turbulence has been the Government’s five-year spending plans for rail, water, roads and energy projects. As a result, infrastructure has seen staggering growth with output in the sector some 39% higher in Q3 2021 than it was in the same quarter one year earlier – eclipsing growth in all other sectors.

In Q3 2021, the quarterly ‘All Work’ construction output series fell for the first time since Q2 2020 but recovering from the pandemic was never going to be plain sailing. Despite the 1% drop in output in Q3, there has been significantly less volatility in 2021 compared to the previous year and data from October and November indicates that Q4 2021 will see another quarter of stable construction output.

2201 Q1 TPI Graphs 2022 Web UK Construction New Orders

However, looking beyond 2021, the CPA’s autumn forecast downgraded output growth for 2022, blaming ongoing supply issues and rising energy prices. The revised forecast for output growth in 2022 is down from 6.3% to 4.8% as skills and material shortages, cost inflation, rising energy prices and a shortage of HGV drivers are all expected to put “unprecedented” constraints on growth over the next 12 months.

Turning to new work, ONS new order values in Q3 2021 remained above the five-year quarterly average of £11.9bn, but only just. After peaking in Q2 new orders dropped by more than 9% in Q3 (to £12.1bn) as shortages and supply chain issues took a toll on confidence. However, more recent data from construction purchasing managers indicates that after a significant dip in Q3, new orders have been slowly recovering. In tandem with reduced supply chain pressures, the IHS Markit New Orders Index has begun to edge higher in recent months. The index registered 54.8 in December, up from 54.4 in the previous month and the highest reading since August. Although client demand improved towards the end of 2021, the speed of expansion remains much weaker than the peak seen in May 2021 and there are concerns that the lack of new work will not be able to sustain the rapid growth rates seen earlier in 2021.

2201 Q1 TPI Graphs 2022 Web New Orders Index