Key inflationary and deflationary pressures
Based on our observations of the market in tender returns, survey feedback and our extensive discussions with the supply chain, we have established that a number of inflationary and deflationary pressures are likely to impact tender pricing. While many of the pressures from our previous TPI report continue to impact tender pricing, the Ukraine crisis has exacerbated many existing inflationary factors as well as creating a few new ones. Consequently, the number and severity of inflationary pressures continue to far outweigh any current or potential deflationary pressures.
- Interrupted global supply chains and new bottlenecks in wake of Ukraine conflict, forcing some to seek alternative sources of supply at greater cost
- Elevated fuel and energy prices increasing material production and transport/logistics costs
- Limited direct exposure from materials exported from Russia overall, but more heavily exported items (rebar, asphalt, and certain wood products) are at risk supply availability and cost inflation
- Red diesel rebate ban in construction increasing operational cost of running plant/machinery on site
- High vacancy levels, an aging workforce and skills shortages are increasing labour rates and the cost of employee retention
- Growing risk of contractor insolvencies if contracts have been won on lower prices pre-Ukraine conflict. Insolvencies would reduce supply chain capacity and tendering competition
- Strong and stable public sector spending/investment pipeline, leading to increased construction activity and competition for resources
- Low freight availability and port congestion adding upward price pressure
- Increased NIC rates from April
- Strong contractor pipelines easing immediate pressure to win new work. Greater ability to be selective
- Contractors targeting higher margins and increasing risk allowances/premiums
- Widespread awareness of global inflationary pressures generally allowing for potential profiteering and artificial inflationary uplifts
- Retreat from globalisation and return to protectionism (eg decoupling accompanied by reshoring/near-shoring of manufacturing and production to higher-cost regions)
- Cost of living crisis prompting consumers to spend less. Resulting investor uncertainty may see a reduction in construction activity and output growth
- Supply chains will eventually adapt to interrupted trade flows and establish new trading partners
- Higher input costs may lead to project deferrals or cancellations, reducing pipeline and increasing tendering competition in the medium to long-term
- Stagflationary conditions and risk of UK recession potentially impacting client investment plans and spending decisions
- Improving productivity through adoption of digital practices and new/more productive ways of working
- Some cost absorption by contractors looking to secure workload for 2023 and beyond
- If interest rates continue to rise significantly, increased borrowing costs may impact investor demand
In G&T’s Russia-Ukraine Conflict Report, we explored to what extent the UK is exposed to the impacts of the Ukraine crisis, and how it might impact construction costs. In it, we included a scenario-based fan chart outlining how three possible scenarios could potentially impact tender price inflation. In each scenario various supply, demand and macro-economic conditions and qualifying criteria were outlined.
Since publication of the report, it has become clear that the situation has evolved, increasing in severity and moving beyond what was originally described as our ‘Limited Disruption Scenario’. Many of the conditions outlined in our ‘Intermediate scenario’ have now been met and so we have updated our fan chart to show what are now the two most relevant scenarios – the ‘Intermediate’ and the ‘Substantial’ disruption scenarios.
The chart below shows G&T’s latest weighted UK average TPI forecast, which now sits roughly in between the upper and lower inflationary ranges of the Intermediate scenario. Also displayed are the upper and lower ranges of the Substantial disruption scenario. Descriptions of each scenario, and the relevant qualifying conditions for each, are provided in our Russia-Ukraine Conflict Report.
Construction input cost inflation is being heavily driven by material price increases. Trades that are heavily fuel/energy-driven or materials-based are experiencing the worst of the inflationary pressure (eg steel, M&E, concrete, brick/blockwork and even roofing due higher bitumen costs – a by-product of petroleum of which Russia is a major supplier). Carpentry and joinery are also being impacted by interrupted supplies of timber from Ukraine. While there is a good supply of most products and materials across the UK, challenges remain for materials such as bricks/ blocks, roofing products, boilers etc, all of which have long lead times.
BEIS data is yet to show the impact of the Russia-Ukraine war on material prices, but the ‘All Work’ index rose by 1.2% in February – its largest monthly increase in six months. The rise came after a reduction in the rate of material price inflation (ie disinflation) in the final half of 2021 as supply/demand imbalances caused by the pandemic began to normalise. However, unprecedented rises in fuel and energy prices have since spurred a second wave of post-pandemic inflation.
March’s UK construction PMI survey data (which does capture the early effects of the conflict) showed a sharp uptick in input prices, indicating that any levelling off of material price inflation was merely a brief pause in what is set to be an otherwise sustained upward trend. The survey’s Input Prices Index rose to 88.7 – the highest reading since last September. Surveyed purchasing managers noted that the war in Ukraine had driven up commodity prices and haulage costs, resulting in across the board rises in average cost burdens for all construction firms.
These recent material price rises are largely a result of surging wholesale gas and electricity prices increasing production costs for energy-intensive materials. An in-depth review of which materials and trade packages will be most affected by the Ukraine crisis is outlined in our Russia-Ukraine Conflict report, but according to the Construction Leadership Council (CLC), the war’s impact on UK construction is “only beginning to be felt”. Many items such as metals and electrical goods have already seen double-digit rises – rises that are being stacked on top of already significantly inflated key material prices seen prior to the conflict.
Fabricated structural steel sections, for example, were already 65% higher in February 2022 than they were just before the pandemic hit. Since then, British Steel has announced an additional £250/tonne increase for all new orders, followed by another £100/tonne in early April. British Steel blamed the sustained high level of steelmaking costs and continued disruption to international trade flows for the hikes. With the supply chain anticipating further price rises, customers are placing new orders at a record pace, thinking that if they do not buy now and fix costs, in a few months’ time steel will be even more expensive.
While similar problems are being felt by steelmakers across Europe, the situation is particularly acute in the UK. The UK steel industry faces electricity prices that are 50-60% above those faced by steelmakers in France and Germany due to environmental policies, a reliance on gas, as well as power transmission and carbon permit costs above those in Europe. For now, customers are accepting price increases but if demand slows, producers may have to increasingly halt production in response to surging prices. Steelmakers, such as ArcelorMittal, have already been operating their electric arc furnaces cross European sites in a stop-start mode for some months to avoid peak electricity prices.
BEIS material price data shows that cement, ready-mixed concrete and pre-cast-concrete products were already edging higher prior to the Ukraine crisis, but spiking energy prices will likely induce a step change to inflation rates in the coming months as natural gas fuels cement kilns as part of the production process.
According to the CLC, due to higher copper, steel and aluminium prices, as well as supply shortages of neon from major producers in Odessa and Mariupol and COVID-related bottlenecks for microchips and semiconductors from Asia, the electrotechnical sector is now experiencing inflation on products above 20%. MEP suppliers expect further price impact in the coming months. High aluminium prices will impact lifts, heat exchangers and fans, while steel-related products (eg M&E containment, pipework, conveyance products and fabricated products) are all likely to experience significant price rises. Record high copper prices will see pipework, conveyance products, cabling and general system components all increase, while high gas prices will increase the cost of refrigerant gas.
There is some inconsistent messaging with regards to labour availability. Some Main Contractors indicate they are not currently struggling with skills shortages, stating that Brexit has actually had relatively little impact on labour availability. Several Tier one Main contractors also said there has been little, non-standard changes to rates or availability. However, other contractors are stating there is very low availability of both staff and project labour resource, noting the dearth of skilled construction workers has been decades in the making and the shortfalls have been compounded during the pandemic. Regardless, almost all contractors expect sustained upward pressure on labour rates as workers move around to secure the highest rates amid a ‘cost of living crisis’ and contractors try to retain skilled workers.
Official ONS data (which covers all roles within the construction industry) suggests that construction average weekly earnings increased by 3.7% year-on-year to February 2022. This annual growth rate is higher than the industry’s long-term average annual growth rate of 2.9% but is well below the wage growth seen over the past year from the whole economy (5.4%).
While ONS data suggests that average weekly earnings (total pay) in February was £689/week, rates from Hudson Contract suggest that labour rates on building sites in London are much higher. Weekly earnings for self-employed tradespeople hit £1,027 in London during March according to the payroll provider – a 13.1% year-on-year increase. Other regions, such as the East Midlands, saw similar earnings growth rates, helping to push the AWE figure across England and Wales as a whole to an all-time high of £959 in March.
To hit record earnings at this time of year (when sites are hit by adverse weather and lower activity levels) suggests that the remainder of 2022 will be a strong year for workload and earnings. Even though there may be fewer tenders coming through due to the issues around material price inflation, labour rates are being driven higher by strong pent-up demand and full order books.
Staffing numbers continue to rise according to purchasing managers, but the rate of job creation eased to its least marked since December 2021 according to the March UK Construction PMI survey. This slower employment growth was attributed to tight labour market conditions and a lack of suitable skilled candidates to fill vacancies. That said, official UK construction vacancy levels remain indicative of strong underlying momentum. According to the ONS, vacancies were the highest they have been in more than 20 years at 48,000 between January-March 2022, while the total number of construction employees remains well below pre-pandemic levels.
Vacancies are evidently proving difficult to fill, growing faster than any other sector in Q1 2022. The number of construction jobs that need to be filled grew by 18.7% in the three months to March, amid a bigger picture that the labour force of the entire economy is contracting. While it is certainly still possible to hire from the EU (albeit with additional bureaucracy and extra cost), job applications are down on pre-pandemic levels, which is widening the skills deficit. This will ultimately add pressure on contractors to increase rates and improve training and work conditions.
In addition, there is potential for further labour shortages as Ukraine goes through a re-building process and an aging construction workforce retires. What is clear is that the age of cheap, steady streams of labour from the continent is over.
 Year-on-year, three-month average to February 2022