Input Costs

Key Inflationary Drivers

With labour cost inflation showing signs of easing, material prices are once again on the rise. In addition to this, construction costs and tender pricing are being driven by several other pressures, including stricter regulatory requirements, planning challenges, supply chain consolidation and capacity constraints. The table below highlights these key drivers, while also identifying the deflationary forces that are partially offsetting these cost increases – such as weaker demand for new orders, the need to keep available teams occupied and the importance of securing cash flow.

MATERIALS TRENDS

On an aggregate basis, construction material prices have seen little movement over the past six months, indicating supply and demand pressures have been broadly balanced. However, the latest data suggests prices are beginning to edge higher as demand conditions improve and logistical challenges and supply risks remain.

The Department of Business and Trade’s (DBT) ‘All-Work’ index – a basket of goods that tracks price movements for construction materials – has fallen 2.2% over the past year (and 5% since its peak in July 2022). However, compared to early 2020 levels, before the pandemic, material prices remain approximately 39% higher.

Over the past 18-24 months, weaker demand for key construction materials has limited manufacturers' ability to fully pass on rising input costs. However, with demand showing tentative signs of a recovery, manufacturers may seize the opportunity to increase prices and recoup historic losses, potentially leading to higher costs across the construction sector. The latest data from the DBT signals the beginning of a transitional phase in the market, where pricing power gradually returns to suppliers, impacting project budgets.

While some indicators point to a potential reversal in recent material price trends, a recovery is unlikely to be uniform across all product categories. Variations are expected based on the nature of the recovery and shifts in supply and demand dynamics withing specific sectors. For instance, if Labour's housebuilding targets are met, brick production may struggle to keep pace with demand, leading to price surges. The reduction in domestic production capacity over recent years will also impact pricing dynamics for locally produced heavy-side building materials, such as bricks. Conversely, steel prices may remain relatively stable due to an uncertain global demand outlook

Although inflationary pressures have stabilised and monthly price movements have become less volatile, data from the DBT indicate that certain product categories are still experiencing price growth. Timber saw the highest rate of inflation during the three months leading up to June 2024, with prices rising by 3.3%. This increase was largely driven by reduced production volumes, shrinking stockpiles, and rising production and transportation costs.

Other materials, such as pipes and fittings (+3.1%) and aggregates (+2.9%), also experienced upward pressure. Ready-mixed concrete prices increased by 2% during the same period, driven by strong demand for low-carbon variants that carry higher production costs. However, there are signs that concrete prices may be reaching a plateau, potentially indicating a balance between supply and demand in this segment.

It is also worth noting the impact of higher shipping costs on imported products. The cost of moving a 40ft container between Asia and northern Europe at short notice has more than doubled since April, from $3,223 to $8,461, following an intensification of Houthi rebel attacks on ships travelling through the Red Sea to the Suez Canal. Heightened political tensions are an upside risk to freight costs, and with a consumer-led recovery gathering strength in Europe and the UK, there is now more potential for companies to pass these costs on. If sustained, higher shipping costs will appear in prices for imported construction products at some point.

LABOUR TRENDS

Labour costs are currently the primary driver of construction input cost inflation, but pressure has eased considerably in recent months.

Following the post-pandemic recovery phase (mid-2020 to mid-2021), where there was a surge in construction activity as projects resumed and new schemes began, vacancies began to decline noticeably. The decline was driven by several factors – high inflation, supply chain issues, rising interest rates and an economic slowdown – all of which led to weaker new order growth and softer demand for labour (dampening employment and recruitment activity over the past year).

Despite returning towards normal levels, vacancies remain above the 10-year average. Leading sentiment indicators (eg the construction PMI) suggest firms are once again beginning to expand their staffing levels. The rate of job creation has quickened in recent months following expectations of rising workloads.

Against this backdrop, average weekly earnings rose 3.2% in June on an annual, three-month average basis. This marked a sharp recovery in construction earnings from the previous month, where annual growth was just 1.9% – the lowest period-on-period growth rate in three years. While earnings data is inherently volatile, June’s figures indicate that even as earnings growth in the wider economy slowed, construction wages rebounded, aligning with long-term average growth rates.

Earnings data from the ONS provide a broad overview of construction earnings trends, but the picture is more nuanced. Directly employed site workers were able to leverage their collective bargaining power to secure a 6% wage increase in July 2023 under a CIJC deal, with an additional 1.5% increase effective from 1^st January 2024. This results in a compounded total increase of 7.59%. In June 2024, the Building and Allied Trades Joint Industrial Council (BATJIC) also agreed a 4% pay rise over the next year, affecting workers employed by small builders.

This disparity indicates that the weaker annual earnings growth over the past year has primarily impacted self-employed tradespeople, who have less bargaining power and are more vulnerable to market fluctuations and reduced demand. Supporting this, data from payroll provider Hudson Contract shows that the average pay increase for self-employed operatives across all regions was just 1.25% in the year to June 2024 – a figure more closely aligned to May’s ONS earnings data.[1]

Construction wage growth may be easing overall, but structural shortages and constraints remain. The industry continues to grapple with a shrinking labour pool due to demographic trends and reduced access to skilled migrant labour. April’s increase in the minimum salary threshold for Skilled Worker visas to £38,700 – a 48% rise from the previous threshold – further intensifies these pressures. Additionally, the new Immigration Salary List (ISL), which replaced the Shortage Occupation List (SOL), now mandates a minimum salary of £30,960 for roles on the ISL, or the occupation-specific threshold if higher. This is less generous than the 20% ‘going-rate’ salary discount for shortage occupation under the SOL, making the Skilled Worker route unviable for many occupations.

As demand for construction improves, these constraints will maintain a level of pressure on skilled labour costs as companies seek to retain and attract workers.

ON-COSTS

Preliminaries costs are facing continued upward pressure due to rising insurance and bond costs. Additionally, site setup expenses, such as temporary electrics, utilities, consumables and health and safety measures, are increasing. Rising staff costs and the impact of compliance-related requirements under the Building Safety Act are further driving inflation within preliminaries.

Over the next 12 months, opinion is broadly divided on whether preliminaries costs (as a percentage of total project costs) will remain stable or rise further. Proponents of a rise argue that as workloads recover and the contractor pool shrinks, firms will be in a stronger position to pass on increased staff costs and other inflationary pressures, including those from new regulatory requirements and carbon counting. Conversely, those expecting costs to remain steady suggest that until new orders pick up, higher staffing costs and other inflationary pressures may be mitigated by competitive pricing due to reduced workloads. In the short-term, we may see competitive preliminaries for the right client and project.

Overheads and profit (OH&P) remain the more stable out of the two cost elements, with the vast majority of survey respondents reporting little change over the last quarter. Despite the slowdown in new order growth, contractors have maintained a cautious approach, pricing work prudently with appropriate allowances for profit and risk, while anticipating a recovery in late 2024. However, notable variation exists based on project value, with schemes costing less than £15 million more likely to have seen an increase in OH&P levels over the past three months. Smaller projects often carry higher relative administrative and compliance costs, as fixed overheads are spread across a smaller budget. To offset these higher per-unit costs, contractors are adjusting OH&P upwards.

Over the next 12 months, if new order volumes continue to grow, contractors may face less pressure to aggressively compete on returns and controllable costs to secure work. Furthermore, the combination of reduced capacity in the contracting market and increased insolvency risks will bolster support for maintaining or even increasing OH&P levels.