Q2 2023

Our Forecasts

Prospects for the UK economy have improved in recent months, but the possibility of an economic slowdown in 2023 still looms. In construction, forward pipelines remain resilient, but the record-high levels of output and demand seen over the past two years are unlikely to be sustained with forecasters expecting weaker construction activity in 2023.

However, the construction market is still busy largely due to the spill over effects of a strong 2022, with some contractors continuing to struggle with tendering and capacity to bid on new orders. Sustained demand has also allowed contractors to continue to be selective but tendering conditions are showing some signs of moderating. High interest rates and elevated construction costs have curbed demand in recent months, prompting softer tendering competition in some instances.

Reflecting the general economic trend, the industry has moved from high growth to stabilisation. Project starts, contract awards and planning approvals have all largely been on a downward trend since Q3 2022. Contractors are currently being supported by a strong base level of tendering opportunities and a historic pipeline of committed work that will be built out over the next 6-12 months, but if activity continues to soften then contractors will have to consider their pricing strategies.

With the prospect of more competitive tendering in the second half of 2023 and evidence of easing input cost inflation, a buying window could be opening. Our 2023 UK average TPI forecast of 2.75% remains unchanged from the previous quarter. However, high interest rates and borrowing costs will undoubtedly weigh on demand and new construction orders. As contractor pipeline’s dry and the rate of input cost inflation continues to soften, we would expect tender pricing to ease further in H2 2023. The inflationary profile for 2023 will therefore be one of higher tender price inflation in the first half of the year and lower inflation in the second half. We expect lower levels of inflation will continue into 2024, as our UK TPI forecast drops to 2.25% - below our long-term annual average.

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.

Macro Economics and Input Costs

The Economy

The UK economy has fared better than many forecast but the outlook is still weak. Growth is expected to be flat in Q1 once figures are released narrowly avoiding technical recession in 2023, according to the Office of Budget Responsibility (OBR). However, a small contraction of 0.2% for the year is expected.

The OBR is projecting that (CPI) inflation will fall to 2.9% by the end of 2023 as the energy price spikes drop out of the annual comparison. However, this forecast relies on several assumptions and there are significant risks that inflation may not fall so quickly. UK wage growth is still historically strong which could mean higher service sector inflation and labour costs. From a global perspective, a further escalation in the war in Ukraine and manipulation by OPEC could also see energy prices jump again. The lifting of COVID restrictions in China could increase demand for gas and commodities, pushing prices up and slowing the pace at which inflation drops. These factors could result in potentially “stickier” headline inflation.

Conversely, a change in the weightings on the CPI index to include a greater proportion of gas and electricity (from 3.6% to 4.8%) is expected to accelerate the decline in inflation. Any falls in energy prices will have a strong drag effect on overall rates for the rest of the year.

The UK Central Bank’s interest rate hiking cycle is likely to slow and come to an end. However, February’s unexpected rise in CPI casts some doubt that the regulator’s job is done. Further interest rate hikes may be needed to reduce inflationary pressures, with BoE governor indicating a willingness to do this – even amid the recent turmoil in the banking sector. Falling inflation isn’t inevitable and higher borrowing costs will be with us for longer. This uncertainty will doubtless bring a degree of volatility in the markets until clearer and more consistent trends are seen.

Although the economy is sending some mixed signals, it has been surprising how strong to upside growth the UK has been. Strong balance sheets post the financial crisis have helped make businesses and consumers more resilient to interest rate hikes. A soft landing scenario in which borrowing and spending slow just enough to tame inflation without tipping the economy into a recession appears likely to most commentators. But the inflation battle is still far from being won with continued volatility leaving a question mark around the outlook for the UK growth.

Construction Output and New Orders

While contracting 1.7% in January – one of its worst months over the past two years – construction output remains 4.4% above the five-year monthly average and 2% higher than before the pandemic in February 2020.

January’s drop was driven by economic uncertainty (which led to delays and cancellations of projects) as well as exceptionally bad weather. Output in all new work sectors contracted in January with the exception of the private industrial sector. Conversely, repair and maintenance work sectors all grew, partly offsetting the weaker performance of new work growth.

Construction Output: All Work, Seasonally Adjusted

Uncertainty over future growth prospects and higher interest rates also had an impact on client demand, and consequently new work growth in the final quarter of 2022. New orders fell 4.3% in Q4 but, like output, remained above the five-year quarterly average. However, the outlook has improved somewhat since.

The construction purchasing manager’s index (PMI) returned to growth after two months of contracting construction activity. Activity beat expectations to register the highest growth rate in nine months, pushed higher by growing order books and a modest improvement in employment numbers. With the majority of businesses now reporting an expansion in activity, the index paints a brighter picture than it did just a few short months ago. ‘Robust’ continues to be the word attributed to the industry after successfully dealing with numerous headwinds over the past few years, but the industry is not immune to the effects of wider economic pressures. Construction output is forecast to slow this year (by as much as 4.7% according to the CPA), but the extent of any slowdown will largely depend on client confidence in demand as well as input cost inflation.

UK Construction: New Orders