Key inflationary and deflationary pressures
A normalisation in supply conditions in recent months has helped alleviate cost pressures across the construction sector, with the rate of overall input cost inflation easing.
The latest BCIS input cost metrics show plant costs dropped significantly (-3.5%) between January-May and are forecast to fall even further as lower fuel/energy prices reduce the cost of operating plant on site. However, the BCIS Materials and Labour Cost Indices rose by 3.2% and 0.9% respectively over the period, but it’s worth noting that the index figures between March and May are provisional and may change once factory gate prices and nationally agreed wage awards are published.
The BCIS Materials Cost Index began to level off in June and dipped in the second half of 2022. This was helped by a negative economic outlook, an improved balance between supply and demand and a normalisation of supply chain conditions following the initial impact of war in Ukraine. While materials prices are still expected to rise in 2023, this will likely be at a much slower rate compared to the past two years.
Labour is set to become the main cost driver this year. The BCIS Labour Cost index is expected to rise by 7.7% in 2023, compared to a 5.6% contraction in the BCIS Plant Cost Index and 3.5% for the BCIS Materials Cost Index. The long-term issue of systematic skills shortages will become a more pressing concern for clients, potentially extending lead times and forcing contractors to re-scope projects if not addressed.
Falling wholesale energy prices and improvements in product availability following a series of supply chain disruptions have helped soften material price inflation.
According to the BEIS All-Work index (a basket of goods that tracks price movements for construction materials), material prices in May 2023 were 1.5% higher than they were a year ago. The collective easing in the rate of material price inflation was driven by price falls for a handful of key materials, such as imported timber, structural steel and rebar – some of the most heavily inflated materials over the past in 2021/22. However, prices for some product categories (eg insulating materials, concrete/cement) are still rising.
Although volatile energy price movements remain a significant upside risk to material prices in 2023, on the demand side, economic uncertainty and a slowdown in the new-build sector cause a drop in demand for heavy materials such as steel, bricks and timber. This has allowed manufacturers to rebuild inventory/stock levels for these products and improve the supply-demand balance.
Issues around materials shortages have largely been resolved, with availability returning to pre-pandemic levels of most materials. However, a few pressure points remain and delays therefore need to be managed for materials/products such as electronic chips, MEP component parts, insulation, sprinklers and even cladding. Overall, though, main contractors are reporting increased stability in lead times. Although very little is ‘off the shelf’ anymore, most materials are available providing the project cost base is correct and the design is completed early enough to allow for supply chain lead times.
Although price volatility has calmed, further hikes to materials are still an acute risk. Potential risk factors include an escalation in the war in Ukraine (causing further energy price destabilisation), rising wages pushing up the cost of manufacturing materials and increasing scrutiny from regulators with regards to how manufacturers test and market their products. Due to the effects of lags and energy hedging, it may also take some time for the benefits of stabilising material prices to fully filter through the supply chain. Furthermore, to recover past losses resulting from their inability to fully transfer the initial surge in input costs, manufacturers will also want to maintain elevated prices for as long as possible.
For now, the combination of factors that drove inflation in 2021 and 2022 appear to have passed. Energy pressures, excess demand and supply chain bottlenecks have largely fallen away. Additionally, the reopening of China did not see demand for raw commodities and materials ramp up as much as many expected. Chinese demand for iron ore and steel has collapsed in recent months, driving prices lower. Weakness in China’s construction sector has also undermined other metals, such aluminium, prompting some processors and trading firms to sell inventories into a weakening domestic market rather than store it for later sale to end-users. Accordingly, aluminium prices have trended lower.
With energy prices also set to fall out of the equation, we would expect prices for many construction materials to soften.
Labour supply issues and skills shortages continue to put pressure on input costs. In G&T’s recent survey of main contractors, respondents explained that the decline of the Eastern European workforce post Brexit was a key contributing factor to the low levels of availability of project labour resource. Others attributed the current labour availability issues to increased staff mobility, the poaching of resource driven by supply and demand factors and pressure on wages to retain labour. The post-pandemic phenomenon of falling participation (both in terms of the ageing of the population and higher rates of inactivity among those of working age) has also tightened labour supply over the past couple of years.
For many, labour shortages have become an increasingly limiting factor to growth. Recruiting good quality candidates to fill roles has become increasingly difficult and there are growing premiums to secure certain trades and staff roles.
With availability issues compounding with cost-of-living pressures, construction average weekly earnings continue to rise. According to the ONS, construction wages were up 4.8% in April 2023 in the year-on-year, three-month average series – still well above the long-term average annual change of 3.1%.
A reduction in the number of construction vacancies of late has not been enough to reduce pressure on construction earnings either. UK construction vacancies fell to 40,000 in Q1 2023 but remain significantly higher compared to historical average levels of c.24,000 over the last 25 years.
Recruitment activity and job creation may have eased (perhaps making it a little easier to fill existing vacancies) but construction output has held up so far in 2023. Strong, current levels of activity on site, sustained high vacancies and skills shortages will continue to exert upward pressure on earnings and, in turn, tender prices as contractors pass on higher costs.
There is a possibility of some shorter-term relief to construction labour cost pressures on the horizon. The Construction Leadership Council (CLC) is pressing for immigration restrictions to be eased for a wider range of construction trades. An updated version of its report of shortage occupations in construction – which builds on its first report that was successful in securing the inclusion of certain occupations like bricklayers – calls for more roles to be added to the Government’s shortage occupation list. Roles such as carpenters and joiners, as well as plasterers, dry liners and ceiling fixers have been included. The CLC argues that the successful execution of nationally prioritised infrastructure projects relies on filling these specific roles with workers that are inherently in short supply.
Initiatives like the widening of the shortage occupation list may help to ease pressure on wages by bringing down vacancy rates and alleviating certain recruitment pressures. If, as anticipated, output and new order growth also continue to ease, construction wage growth should return to more normal levels in the medium-term.
In ‘percentage-of-total-project-cost’ terms, project preliminaries saw no real change in Q2 2023, but overall preliminaries costs continued to rise due to fixed energy-related factors/consumption on site, as well as staff wage increases. Main contractor Overhead and Profit (OH&P) also remained stable given that the volume of opportunities across most sectors meant that contractors could still pick and choose which tenders to pursue.
With sustained workloads at present, contractors aren’t being squeezed to reduce OH&P, or even preliminaries. However, looking ahead, we would expect stiffer tendering competition as new orders ease, putting some downward pressure on OH&P. With regards to preliminaries, many anticipate that construction firms will have to compete harder for labour resource, potentially pushing preliminaries costs higher unless cooled by reduced demand.
Other pressures acting to increase OH&P and preliminaries costs include rising borrowing costs, higher insurance costs, sustainability measures, and onerous Local Authority requirements. Contractors will naturally look to cover these additional costs by raising their preliminaries levels and OH&P.