Macro Economics

After a contraction in UK GDP of 0.2% in Q2 2019, GDP recovered in July, rising by 0.3% and beating City forecasts of 0.1% growth. This meant rolling GDP growth was flat in the three months to July. Economists now expect that the UK will avoid a technical recession and grow in Q3, speculating that further stockpiling prior to the October Brexit deadline will boost growth.

Whilst manufacturing, services and construction industries all expanded in July, the three-month data series tells a slightly different story. In the three months to July, services was the only positive contributor to GDP growth, growing by 0.2%. Output in manufacturing and construction both acted as a drag on GDP growth over the period, contracting by 1.1% and 0.8% respectively.

Construction’s disappointing performance was driven by a fall in private housing repair and maintenance and public other new work, which fell by 6.3% and 6.2% respectively in the three months to July. However, the more positive month-on-month growth figure of 0.5% in July was driven by private new housing and public housing repair and maintenance.

The more recent PMI data from August found that commercial continues to be the worst performing sector. According to the survey new orders contracted for the fifth consecutive month in August with commercial construction leading the decline. Fuelled by high competition for new work and reluctant clients putting off committing to contracts, commercial activity fell at a steep and accelerated pace in the month.

However, commercial isn’t the only sector being hit by Brexit uncertainty. Civil engineering and housebuilding activity also dropped in the month. The PMI survey also found that input cost inflation fell to its lowest level since March 2016 due to softer demand for construction products and materials. As a consequence respondents noted that this has helped to alleviate some of the pressure on the supply chain and has helped to lower delivery times.

The Consumer Price Index (CPI) 12-month inflation rate was 1.7% in August 2019, down from 2.1% in July. Inflation is now at its lowest level in almost three years. Economists believe that fears over Brexit and a slowdown in the economy may have discouraged businesses from raising prices. Firms may be waiting to see beyond 31^st October before making price adjustments. A no-deal Brexit and a weaker Pound would drive up the inflation rate in Q4. Concerns over oil supply are also likely to lead to increased input costs, raising prices across the supply chain.

Average weekly earnings (total pay) rose at an annual pace of 4% in the three months to July, in a sign that the labour market is surpassing expectations. Once adjusted for inflation UK wages rose above 2% for the first time in nearly four years. However, there are early signs that the labour market is cooling with lower than anticipated job creation and vacancies falling to their lowest level since November 2017. The unemployment rate fell to 3.8% in the three months to July 2019 - back to its joint lowest since the three months to January 1975.

Despite inflation being reasonably close to its 2% target, strong wage growth and low unemployment, the Bank of England (BoE) is expected to keep interest rates on hold at 0.75% until the outcome of Brexit is known. With a deal in place the BoE has said that it plans to resume a gradual and limited series of interest rates hikes. Without a deal, the bank is likely to cut interest rates to support the economy during a likely shock.

CONSTRUCTION OUTPUT

In the three months to the end of July 2019, construction output fell by 0.8% compared to the previous three month period. The fall meant that most of the output growth seen in the previous three month period to April 2019 was given up in the three months to the end of July.

Construction output growth has been relatively flat since January 2017. Before Brexit-related uncertainty began to take its toll, construction output enjoyed a steady period of growth from early 2013. However, since the referendum, real output has expanded at approximately half the pace of the previous three years, with the monthly ‘All Work’ construction output figure hovering around £13bn - a clear sign that spending decisions continue to be put on hold in this confusing landscape.

Looking at the various sectors, Repair and Maintenance work has suffered the most in 2019. It's weakness has acted as a drag on All Work output. New Work output has performed slightly better but growth has still been largely flat in 2019. Over the previous 12-month period, the sector that has experienced the most growth has been public new housing (14.2%), closely followed by new infrastructure work (12.1%). Despite falling by -11.7% in July, public housing clearly benefitted in the months leading up to and after the removal of the Housing Revenue Account (HRA) borrowing cap in October 2018. Whilst there are still disincentives for councils to build new public housing, being able to take on additional debt to fund affordable public housing may allow local governments to once again become a major developer.

Although output growth in infrastructure has been fairly static in the first half of 2019, growth in the second half in 2018 was very strong. Many will be eagerly anticipating further details on the Chancellor’s promised “infrastructure spending revolution” that are due to be revealed in the National Infrastructure Strategy later this autumn. Amid reports of a lack of replacement work and large projects such as HS2 in doubt, infrastructure spending commitments will provide a welcome boost.

The worst performing subsector was private housing repair and maintenance (down 12.6% in the year to July 2019). Households are reining in home improvement spending and the removal of benefits and tax advantages for private landlords has had a detrimental impact as landlords also have less money to make improvements. Public other new work has also performed badly over the past year, with output falling by 8.9% over the period. A lack of investment in public sector buildings over the past three years has impacted output growth.

Once again, the August 2019 IHS Markit UK construction PMI survey found that the commercial sector was the worst performing in terms of construction activity. The commercial activity index fell at a steep and accelerated pace in August as a consequence of increased risk aversion and delayed project starts. According to survey results, the commercial sector also experienced the fastest drop in new orders since March 2009 so it’s unlikely that we’ll see a return to strong commercial output growth in the short to medium term.

Output growth is likely to remain subdued for the remainder of 2019. A favourable Brexit outcome (ie one which sees the UK leave the EU with a withdrawal agreement in place rather than a no-deal or ‘cliff-edge’ Brexit) leaves the possibility of a post-Brexit bounce, but there will be a lag before this begins to feed into higher output growth.

NEW ORDERS

New order data in Q2 2019 was disappointing. According to the ONS, ‘All New Work’ new orders fell -13.3% between Q1 and Q2 2019, wiping out the 10% rise in new orders enjoyed in the first quarter of 2019. In fact total new orders in Q2 were £10.92bn – the lowest quarterly value since Q1 2013.

New orders in all sub-sectors, other than infrastructure, experienced a contraction in Q2. Public other new work (-26%) and private commercial work (-24%) saw the largest quarter-on-quarter declines. Infrastructure grew in the quarter but only marginally (up 1%) but the ONS noted that a single project in the North West made up 46.1% of the new order value. In London infrastructure new orders actually fell by -94% compared to the previous quarter, making it the worst performing UK region for the sub-sector.

New orders have been volatile since the EU referendum, often experiencing extreme quarterly swings. However, these swings offer further evidence of latent demand as many clients are poised on the side lines waiting until the implications of Brexit become known. Any delayed spending in the run-up to 31^st October will have a negative knock-on effect on output growth in 2020, but if the UK leaves the EU with a deal we may see a surge of deferred investment towards the end of the year.

Supporting the poor new order data from the ONS, August’s PMI survey also noted that its new order sub-index fell to its lowest level since March 2009 in August, dropping to 40 from 44.57 in July (with any value below 50 indicating a contraction). Furthermore, the survey also revealed that business optimism was at its lowest ebb since December 2008 – just one year after the financial crisis. Despite this, G&T continues to experience a steady stream of enquiries and opportunities in the pipeline. Government driven projects in infrastructure, healthcare and education are producing a steady flow of work. The public residential, hotel and hospitality sectors also appear to be fairly active. Whilst the political environment remains uncertain, the supply of new projects will be restrained which may lead to greater competition among contractors and keener pricing.

MARKET CONDITIONS

Our TPI survey found that market conditions are increasingly being described as ‘competitive’. Work progressing to site is still buoyant and many trades are reporting that they are busy.

The market has also been described as ‘balanced’ and ‘stable’, suggesting that whilst not becoming busier, opportunities are still available. However, contractors appear to be more cautious about submitting lower tender bids just to gain turnover and many main contractors appear to be choosing their clients based on potential repeat business further down the line.

Despite being the most commonly used procurement route, many clients appear reluctant to undertake a two-stage tendering process in the current market, as they desire a higher degree of cost certainty and the ability to pass on more of the risk to contractors. Single-stage is being used more regularly as the market becomes more competitive. Contractors have become more willing to contract on this basis so we may see this route becoming more prevalent over the next 12 months

G&T has found that main contractors (particularly tier 2) are increasingly keen on identifying potential projects to fill their order book. Despite some labour and material price inflation, tender prices are being kept in check by increased competition for work. In the short-term, the majority of our TPI survey respondents did not however, the majority of respondents did not expect any major changes in tender pricing in the final quarter of 2019, with the most anticipating zero growth.