Macro Economics

Q4 2019 GDP data is likely to show that the economy limped through the final quarter of the year after GDP growth in Q3 2019 was upwardly revised from 0.3% to 0.4%. The Bank of England (BoE) is forecasting just 0.1% growth in Q4, anticipating that stalled spending, postponed investment plans and political uncertainty will have led to economic stagnation.

UK GDP grew by 0.1% in the three months to November 2019 as the weakening services and falling production sectors resulted in subdued growth. Somewhat surprisingly the construction sector made a positive contribution to GDP growth, growing by 1.1% in the period. This is now the third consecutive rolling three-month period that the sector has grown, with the latest period showing new work output growth of 1.6% and repair and maintenance growth of 0.3%.

Conversely, December’s PMI survey showed a further contraction in activity. In fact, only twice in 2019 (January and April) did the PMI reading manage to show an expansion in activity, but the most recent survey revealed that business confidence rebounded to a nine-month high as a result of the greater clarity provided on Brexit. Respondents noted that this had the potential to boost clients’ willingness to spend and increase order books in 2020.

Consumer price inflation (CPI) fell to 1.3% in December 2019 - its lowest annual growth rate since December 2016 and undershooting the BoE’s inflation target of 2%. Declines in the inflationary measure come amid the backdrop of a stalling economy and a tough Christmas trading period. The BoE’s Monetary Policy Committee recently said that inflation could fall to as low as 1.25% in early 2020, however with Brexit-linked uncertainty improving and wage growth outstripping inflation, CPI could soon creep closer to its target.

Average weekly earnings (total pay) rose at an annual pace of 3.2% in the three months to October 2019 – down from an annual growth rate of 4% that was recorded in the three months to July 2019. Over the period construction saw the highest estimated growth in total pay (5%), exceeding growth in the finance and business services sector (4.3%). This corresponds with our TPI survey responses, several of which noted that construction labour costs continue to rise amid the ongoing skills shortage. Although the UK unemployment rate remains at its lowest level since January 1975 vacancies have fallen for 10 months in a row and pay growth rates slowed as businesses erred on the side of caution in their recruitment plans.

Outgoing BoE Governor Mark Carney said that the central bank could cut interest rates if it looks like weakness in the economy will persist. After the soft inflation data for December, money markets have priced in a 60% chance of a rate cut at Januarys BoE meeting. However, Carney had previously pointed to positive indicators such as a reduction in business uncertainty since the election result as well as signs that global growth is stabilising as potential reasons to keep interest rates on hold for the time being.

CONSTRUCTION OUTPUT

Construction output in the 11 months to November 2019 was up by 2.2% compared to the same period in 2018. New work activity has been particularly strong, growing by 3.1% over the same period.

Output also increased by 1.1% in the three months to November 2019 compared with the previous three-month period. For new work output, all sectors other than private new housing (which saw a fall in output of 0.4%) grew in the three month period. New public housing and private industrial work grew by 4.5% and 6.2% respectively whilst new infrastructure work grew 3% on the previous three months. Public new work output growth languished once again as investment in public sector buildings was dialled back prior to the GE. Unsurprisingly, households were seemingly reluctant to spend over the three-month period as private housing repair and maintenance was the worst performing sub-sector with output falling by 1.9% compared to the previous three- month period.

Whilst construction industry output figures paint a picture of resilience it remains to be seen whether this growth trend can be sustained. Poor new order data (which is tantamount to construction demand) could supress workloads and output growth in the coming months. New orders actually fell by 15% in 2018 compared to the previous year from £54.8bn to £46.3bn. This doesn’t bode particularly well for 2020 construction output figures but there may be a number of projects that could quickly be converted from new orders to shovel-ready projects (ie output) with relatively little lag between the two events.

The Construction Products Association (CPA) has cut its forecast for output growth in 2020 from 1% to 0.5%. Despite concerns over the delivery of some major projects, the CPA anticipates that infrastructure will be one of the primary drivers of output growth 2020. A raft of projects is currently in the pipeline and many more are likely to be announced in Q1 2020, prompting the CPA to forecast a 3.7% rise in infrastructure output growth.

NEW ORDERS

New orders remained stubbornly low in Q3 2019, producing the second lowest ‘All New Work’ value since the second quarter of 2013. The residential sector was the best performing sector by a considerable margin in Q3, with ‘All New Housing’ new orders growing by 8% from the previous quarter. Infrastructure and other public new work continue to struggle, with new orders having declined by 7% and 10% respectively in Q3. Both these struggling sectors however have received funding pledges in the Conservative party manifesto and are likely to bounce back in 2020 once spending details have been revealed in the next Budget.

New orders have trended downwards since the Q2 2016 (around the time of EU referendum), signalling that the uncertain UK political climate has had a notable effect on demand and investor confidence. This has mirrored the downward trend seen in the number of Foreign Direct Investment (FDI) projects in the UK over the same time period. The GE result may help inject some confidence back into the UK market, helping new orders to reverse their downward trend, but a few hurdles remain to be cleared before the UK experiences a sustained rise in business confidence.

According to the latest IHS Markit/ CIPS latest PMI reading, new orders continue to decline at an alarming rate. Although August 2019 still holds the 10-year record for the biggest contraction in new orders, construction companies recorded a marked reduction in new business volumes in December.

The PMI survey also found that commercial work continues to decline as investors opted to postpone spending decisions ahead of the GE. Arguably the sector has been the most exposed to the recent political uncertainty, so assuming that the UK can negotiate a positive trade deal we would expect the sector to stabalise towards the end of this year and into 2021.

After speaking with several contractors G&T found that many expect the market to be busier in 2020, with some going as far as saying that they expect an unprecedented number of projects to be tendered during the year. However, most said that this was unlikely to materialise until Q2 2020 at the earliest.

MARKET CONDITIONS

The general expectation is that the recent slowing of the market will reverse in 2020. The GE result has removed some of the uncertainty but by no means all. The direction of travel is now far clearer, giving some investors and developers greater confidence to plan and move their projects forward.

There is unlikely to be any significant TPI growth until the Government’s spending plans have been confirmed at the next Budget and we have a better steer on the likely trade deal that will be negotiated with the EU. The infrastructure sector is likely to be the major driving force behind much of the expected tender price inflation this coming year. Public spending programmes may help alleviate some of the competition between contractors in the market and ease some of the downward pressure on tendering.

For the first six months of the year we expect contractors to be hungrier as workloads plateau. The number of contractors actively enquiring for projects to fill their order book has been steadily increasing in recent months as existing jobs come to an end. A clear indicator of the current levels of competition in the market has been a greater willingness among contractors to accept a single-stage procurement route. Clients are increasingly wanting contractors to take on more of the risk through single-stage procurement. Six to twelve months ago contractors were unlikely to have accepted this and although two-stage is still the preferred (and most common) procurement route for contractors, single-stage has become more acceptable in this less busy market.

Certain sectors will remain tougher than others in 2020. We are seeing increased activity in hotels and timber offices for example, but even struggling sectors like retail offer a silver-lining as re-purposing projects materialise. In summary, although market risks remain, we are seeing increased market confidence and certainty in the direction of travel.