Q3 2021

Our Forecasts

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‘Transitory inflation’. This is the term currently being bandied about by economists. But transitory or not, inflation is certainly here.

Policymakers and analysts are torn about the potential longevity of this current rash of inflation but most agree that what we are seeing is the result of an initial burst of pent-up demand and economic activity amid intense supply constraints. As demand moderates, the supply chain gets back into shape and the recovery matures, they argue that inflation will begin to ease. As supply and demand start to meet into one place, price pressures will start to normalise.

It is uncommon to have nearly all material prices move upwards at any one time as they have done in recent months. This has put substantial pressure on contractors to pass these rises on through increased tender prices. As we explore in this report, looming large on the horizon and closely following the current material price inflation is the risk of wage-led inflationary growth as demand for skilled workers begins to outpace supply.

Against this backdrop, our inflationary forecasts have been upwardly revised across all regions in 2021. Our resultant weighted UK average indicates that tender price inflation will rise by an average of 2% this year – significantly higher than our previous forecast of 0.5% in Q2 2021. If cost plans were being re-rated and materials procured now, tender price inflation would inevitably be much higher than 2% but it’s important to reiterate that we are forecasting across the whole year, providing an average inflationary rate across all sectors of the built environment. TPI is likely to vary from project-to-project more than ever.

There are signs that material-led input cost inflation has begun to give back some of its advances since the late spring. Commodity prices such as iron ore, copper and timber have all come off the boil in recent weeks which should cast doubt on any inflation-related panic. Production output is recalibrating which should ease most supply-side issues, and once pent-up demand has passed through and begins to normalise, we anticipate that much of the inflationary pressures acting on material prices will ease. From 2022, although we anticipate lower material price growth, construction activity is set to increase driven by public sector spending and Government investment. This could put pressure on labour availability and lead to higher rates. Additionally, demand for commercially funded projects is expected to pick up in 2022 as the economy unlocks and many of the pandemic-related restrictions are brought to an end. We therefore anticipate tender price inflation will rise a further 1.5% next year.

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2107 Tpi Web Assets Tpi London Q3

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.

The Economy

The OECD – the Paris-based think-tank – sharply upgraded its UK economic growth forecasts in light of the UK’s successful vaccination programme. After a 9.8% contraction in 2020, UK GDP is now forecast to rise by 7.2% in 2021 - the fastest growth since 1941. Although this would mean the UK would outpace growth in other advanced economies, the OECD warned that the UK could suffer more longer term damage than other G7 industrialised nations, with the impact of Brexit causing additional adverse supply-side effects and exacerbating the disruption caused by the pandemic.

With the forecasted rebound in economic growth, the Bank of England (BoE) anticipates faster-than-expected increases in inflation. The BoE says that the recovery is likely to push inflation above3% by the end of the year but notes that the rise is “transitory” and should not affect monetary policy. Above target CPI inflation will be temporary and is expected to subside as long-running deflationary forces eventually curtail the recent price rises. Consumer prices hit a two-year high of 2.1% in the year to May, fed by firms paying more for components and putting up their wholesale prices. Factories are struggling to source enough raw materials to keep up with the unleashed pent-up demand, prompting purchasing managers to report sharp rises in input costs.

In addition to supply chain disruption and inflationary concerns, businesses are increasingly reporting labour shortages which is driving wage costs higher. Continued difficulty in hiring for businesses as they try to build back their workforce has pushed UK average weekly earnings (AWE) across all sectors higher. AWE across the whole economy rose by 5.6% in the latest three month period to April compared to one year ago. Hiring activity has seen record increases in the last few months as businesses attempt to bolster capacity and meet the recent surge in demand. This has fed in to higher wage costs which could make the recent spike in inflation even stickier. Labour shortages could also start to become a limiting factor to the recent output growth across all sectors of the economy.

The CBI, however, remains optimistic on UK output, predicting that it will regain its pre-pandemic level by the end of 2021 – a full year earlier than it had previously expected. Government spending (to tackle the virus) will account for half of this year’s forecast rise in GDP but consumer spending will be “the linchpin of the recovery” beyond this year, driving 70% of growth in 2022. The organisation is also increasingly bullish on unemployment, predicting that unemployment would peak at 5.5% in the third quarter of 2021 – higher than its current level of 4.7%, but an earlier and smaller peak than previously feared. The CBI was a little less upbeat on the longer-term UK economic outlook — with business investment set to remain 5% below its pre-pandemic level, even at the end of 2022 and productivity improving over the next year, but only to its already weak pre-pandemic path.

Construction Output and New Orders

Following a strong increase in March, construction output dropped by 2% in April according to ONS figures. Despite the monthly drop, output is still some 0.3% above the February 2020 pre-pandemic level. In April new work was 3.4% below the February 2020 level while repair and maintenance work remained 7.1% above the February 2020 level.

April’s 2% fall in output indicates that growth remains delicate but other indicators (such as the IHS Markit/CIPS UK construction PMI) point to a strong return of confidence in the sector. Total new orders increased for a 13th consecutive month according to June's PMI survey, although the latest expansion was slower than May's survey-record high. The rapid turnaround in demand for new construction work points to a healthy pipeline in the medium to long-term.

Output growth on a sector level has been mixed. Repair and maintenance work has driven growth while new work contracts have generally bucked the trend and declined. Both new infrastructure and non-housing repair and maintenance output grew strongly in April. Private and public industrial new work also grew marginally but all other sectors experienced monthly falls in output. However, any falls in sector output in April have to be considered against a particularly strong March where output in nearly all sectors spiked upwards.

The ONS’ Q1 2021 data provides some reassurance that demand is returning and a recovery is underway. New order values grew by 12.2% in the first quarter of the year and subsequent PMI surveys have indicated that this growth has been sustained in Q2. Furthermore, June's UK construction PMI survey reported that more than half of the survey panel (54%) expect further rises in business activity during the next 12 months - only 7% anticipate a reduction. Consequently, supply chains are struggling to keep pace with the rapid rebound in demand and remain stretched.

Buoyant new order growth has helped take some of the pressure off contractors by easing bidding competition, but many have reported significant losses in the latest financial year and are therefore keen to secure new work and fill their order books by bidding competitively. If new order growth stutters later on in the year, this could result in a more competitive tendering environment, particularly for projects in the £10-20m range and in certain sectors and regions.

*UK Wage Growth (AWE Total Pay) (year-on-year three month average growth to April 2021)