Key inflationary and deflationary pressures
Input cost inflation, which shot up coming out of COVID lockdowns fuelled by the war in Ukraine wreaking havoc on supply chains, is evidently slowing. However, navigating lingering inflation in a way that protects construction businesses and project viability remains a priority in 2023.
The latest BCIS input cost metrics show inputs of materials and plant were the biggest drivers of inflation in 2022, but sharply falling plant costs and a gradual easing in material prices in the latter half of the year alleviated construction cost pressure. Consequently, in H2 2022, the BCIS General Building Cost Index contracted by 2.3% in Q3 and was almost flat in Q4, suggesting the period of high inflation has passed into a more standard or longer-term average rate.
Although labour was the least inflated input cost variable in 2022 (at 4.8%), the BCIS and our forecasts expect labour will be the main cost driver in 2023, with earnings expected to grow by more than 6.5% due to ongoing pressures.
As deflationary pressures mount, a lower rate of inflation is expected in 2023. Improvements in the availability of materials and the balance between supply and demand has helped calm price volatility for construction products, but price hikes later in the year remain an upside risk to inflation.
Drops in wholesale energy and commodity prices are expected to feed into lower material prices in 2023. Concerns remain for certain materials, concrete in particular (with energy costs and demand for low carbon varieties), drylining and imported MEP fitting seeing pressure on prices.
Softer construction activity and a more subdued economic growth outlook has allowed material supply to catch up with demand. Manufacturers have taken advantage of this slowdown to rebuild stock inventory, but shortages continue to pose an operational challenge for wholesalers of certain MEP products such as solar panels, heat pumps and transformers. Cladding, concrete, plasterboard and insulation materials are also experiencing some supply issues but lead times have improved significantly for most products.
The BEIS All-Work Index indicates that normalising supply and demand are alleviating cost pressures. The index is down 4.1% from its peak in July 2022 and, other than an uptick in October, has been on a downward trend.
Even though certain product categories continue to see prices rise, the index has been driven lower overall by a handful of key materials such as imported timber, structural steel, and rebar – some of the most heavily inflated materials over the past 18-24 months.
On the demand-side, economic uncertainty and rising borrowing costs coincided with a slowdown in the new-build sector (in contrast to the buoyancy of refurbishment and energy-efficiency retrofit work). This saw demand for heavy materials such as steel, bricks and timber fall – easing prevailing supply-demand imbalances and price pressure.
Outlook for commodities in 2023 is one of opposing forces: supporting higher prices is Russian supply curtailment, the reopening of China and a prolonged period of underinvestment in production capacity. However, supporting lower prices is the global economic slowdown and the impact of higher borrowing costs weighing on business/consumer sentiment and demand.
For now, at least, an improved supply-demand balance has helped material price inflation to soften, but further price hikes are possible. According to the CLC, some suppliers have simply deferred price increases as demand has slowed, while manufacturers of energy-intensive projects may still need to pass on higher costs having hedged their requirements in 2022 (when wholesale prices were higher). Energy bought at higher rates can often take months to feed through to product prices.
Availability of both supervisory and project labour resource continues to be an issue pushing rates and salary expectations higher, but also affecting outputs as the quality of resource available may not be achieving expected productivity levels.
Construction average weekly earnings saw a minor fall in January 2023 compared to the previous month, but monthly changes can be volatile. The better series to consider is the year-on-year, three-month average change, and in January this was 4.6% – well above the long-term average annual change of 3%.
Many of the structural issues supporting higher labour rates (ie skills shortages) are not expected to change anytime soon, but Government plans to add certain construction workers (such as bricklayers, plasterers, roofers) to a “shortage occupation list” to tackle chronic post-Brexit labour shortages may alleviate some pressure. Labour availability may also improve if workload demand falls, easing competition to secure resource and potentially reducing upward pressure on labour rates.
The rate of job creation is much weaker than seen on average last year, reflecting a dip in new orders and expectations of a slowdown in activity. This is reflected in the declining construction vacancy rate produced by the ONS following a downward trend since the Aug-Oct 2022 period.
Despite falling vacancies and a weaker rate of job creation, labour shortages are prevalent with the market is best described as ‘tight’. Labour costs in trades where there is a lack of capacity due to full short-term order books are also problematic with finishing trades in particular (eg glazing, drylining, joinery, MEP) are experiencing challenges given strong workloads and an undersupply of labour.
Forecasters such as the OBR are expecting overall unemployment to rise moderately from current levels (3.7% to a peak of 4.4% in 2024) as output growth/GDP slows, but this is unlikely to improve construction’s labour shortage issues. Wages are unlikely to be deflationary given pressures on cost of living and will to be the key inflationary cost driver in 2023.
Main Contractor Preliminaries continue to increase in line with labour/wage price increases. High energy and utilities together with insurance premium costs have also put upward pressure on preliminaries over the past one to two years.
Following our TPI survey we anticipate Main Contractor Overhead and Profit (OH&P) levels will remain the same over the course of the year, with downward pressure on margins if there is a significant drop-off in demand and workloads. If market activity does cool significantly in the coming months, contractors may reduce their controllable costs to win work and secure longer-term pipeline. Margins are dependent on the procurement route and project type (including its size and complexity) and client however, strong workloads continue to support OH&P at current levels.