A few significant changes since our previous (Q1 2021) TPI forecast have given rise to some upwardly revised inflationary predictions. COVID-19 has made it difficult to quantify the precise impact of Brexit on trade but the implementation of the EU-UK Trade and Cooperation Agreement has certainly increased non-tariff barriers on UK-EU trade, pushing up prices for European goods and services. Also since our last report the UK’s comparatively successful vaccine programme has exceeded expectations. The speedy rollout has thus far enabled the UK to stick to its roadmap of easing lockdown restrictions, fostering a faster economic revival and outlook. With this, we expect that confidence and investment activity will continue to build and increase the number of tendering opportunities in a number of key sub-sectors.
Accordingly, our weighted UK average TPI forecast for 2021 has risen from -0.5% to 0.5% while our forecast for 2022 has been marginally revised upwards from 1% to 1.25%. From 2023 we anticipate that we’ll continue to edge closer to our long term average rate and expect tender price inflation to grow by a further 1.5% in the year. Although long-range forecasts need to be accompanied with a wide margin of sensitivity, we envision that TPI in 2024 will be circa 1.75% - around half a percentage shy of our long-term average.
We anticipate all regions in the UK to see higher tender prices in 2021 than previously forecast but inflation in some regions is likely to remain flat (eg Wales and the South West). Partners in our Scottish offices were particularly buoyant, noting that the market had not seen a major downturn and that there were a number of big projects and opportunities in the region. Tender price inflation will turn positive in all UK regions in 2022 with inflation in London and the South East recovering strongly to 1.25% as the commercial office sector slowly improves. The Government’s levelling up agenda will help boost construction activity in most UK regions and will be supported by investment in transport, renewable energy, residential and commercial infrastructure projects. We also anticipate that commuter towns with good public transport links could see more construction activity in the coming years.
2021 is shaping up to be a year of two halves. While there is not an influx of schemes being tendered currently, come summer we expect this to change and for greater market activity and rising workloads to prompt tender price inflation to creep up. Some construction sector insolvencies over the last year have created concerns over capacity in the supply chain, which may have a knock-on effect in terms of higher tender price inflation as more projects come to market. With the slowdown in construction activity bottoming out last spring, deflationary pressures will continue to gradually abate resulting in a very different recovery profile for tender price inflation compared to the 2007-08 financial crisis.
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.
*Average Weekly Earnings (Total Pay), Y-on-Y three-month average to Feb 2021.
The OBR forecasts that the UK economy will grow by 4% in 2021 with GDP returning to pre-COVID levels by Q2 2022. The OECD is a little more optimistic with a forecast growth rate of 5.1% for 2021 and 4.7% in 2022. The IMF has also upped its growth forecast for Britain’s economy since January from 4.5% to 5.3% and it believes that UK growth will outpace the euro zone this year.
Upwardly revised forecasts can largely be put down to the UK’s successful vaccination programme. The latest economic data (including output, employment, business sentiment and public finances) has been better than economists had expected and with the UK poised to gradually reopen amid the successful vaccination rollout, the prospects for the immediate economic recovery are strong.
Bank of England (BoE) economists have also become much less gloomy since February’s monetary policy report, with positive data reducing pressure on policymakers to provide further monetary or fiscal boosts. Yes, there will be an overall economic contraction in Q1 2021 (anticipated to be in the region of 2%) but there have been some positive surprises in the form of better-than-expected purchasing managers’ indices and business surveys. The latest construction PMI survey, for example, saw the index jump to 61.7 in March (from 53.3 in February) – indicating a strong uptick in activity and the sharpest pace of expansion since September 2014. The reading also signalled the strongest rate of construction output and new order growth since September 2014 and showed that the rate of job creation was the strongest it’s been in over two years.
Monthly GDP estimates from the ONS show that construction was the only sector to see increased output in January 2021 (0.9% growth month-on-month growth) while all other sectors of the economy saw output contract. Although there is the potential for friction at the end of the EU-UK grace periods, the construction sector has clearly resisted the shock of both Brexit and the pandemic-affected trade flows and has put itself at the forefront of the economic recovery.
From an inflationary perspective, after an unexpected fall in UK CPI to 0.4% in February, inflation returned to 0.7% in March. While forecast to rise sharply in the coming months, the UK remains in a low inflationary environment for the time being. However, inflation is expected to tick higher as lockdown eases and consumers unleash some of the £150bn of excess savings they have built up in the economy. Businesses will also be looking to recoup lost revenues from 2020 and policymakers may be tempted to reduce the debt burden by allowing inflation to creep up. Economists expect the rate to rise sharply in the coming months and exceed 2% later on in the year (mainly driven by rising fuel costs and energy price increases). Tellingly, the Bank of England’s chief economist Andy Haldane recently likened inflation to a “tiger” – something which the central banks will struggle to tame and could require monetary policymakers to act more assertively. In the medium term, however, the BoE sees less upward pressure on inflation due to weakness in the job market, which it expects to persist even after the economy returns to pre-pandemic levels.
Construction Output and New Orders
The v-shaped recovery in construction output tapered off towards the end of 2020 but its 0.9% month-on-month growth in January 2021 is significant given that it is traditionally a quiet month for construction. Although ‘All Work’ output was 2.6% lower in January 2021 compared to the same month one year ago, the ONS’ figures demonstrate the significant resilience of the sector. Giving us a good indication of output growth since January, recent IHS Markit’s PMI surveys have shown positive growth with March’s index reading suggesting that the rate of output growth in the month was the strongest since September 2014. Output growth also appears to have broadened out from housebuilding to commercial and civil engineering work according the survey.
While new orders haven’t mirrored construction output’s recovery (having fallen by 8.8% in Q4 2020 after an impressive 72% increase in Q3) the latest PMI data is very encouraging. Improving demand and contract awards from projects that had been put on hold during the pandemic contributed to a steep upturn in new orders in March. Again, the rate of expansion of new order growth accelerated the fastest since September 2014. Despite this, new order growth has a long way to get back to pre-pandemic levels. In Q4 2020 new orders values were still nearly 13% lower than they were in Q4 2019 and some 17% below the five-year quarterly average of £12bn. New orders are likely to rise in Q1 of this year but growth will be very sector-specific.