Q4 2021

Our Forecasts

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From toilet rolls to timber, supply chain issues have evolved and expanded over the last year-and-a-half.

Rapid demand shifts left manufacturers of construction products and materials struggling to keep up, unable to ramp up production capacity quickly enough to meet the soaring new demand. Perceiving the current supply issues to be short-term, manufacturers saw little point in investing capex into expanding capacity. Instead, they have been happy to accept the higher prices and enjoy increased margins.

There are early signs that record-high material prices across the construction industry have started to soften demand and create some hesitancy regarding new contract awards. Despite this, prices are set to remain ‘sticky’ for a period, resistant to change quickly despite shifts in the market suggesting that a different price is optimal. Falling raw material costs take time to filter through the supply chain and become reflected in prices. Suppliers will also need to sell their existing inventory bought at higher prices and increase their inventory at these lower prices. Retailers will naturally try to hold on to higher prices for as long as they can, particularly when there is still demand.

How long will these supply chain pressures last, exactly? The short answer is, no one knows. The longevity of these issues depends, in part, on whether another round of the pandemic shuts down more countries and what fiscal policy decisions those countries make in the short to medium term. These things are inherently unknowable. Although most see these supply issues as a flash in the pan which will work themselves out as time marches on, it’s important to separate the longer-term structural supply issues from the near-term issues.

There are two inflationary camps: one suggesting that the ‘one-off’ inflationary drivers are transitory, linked to the re-opening of the economy, and that the base effects will disappear or even reverse next year. The other camp suggests there is a broad risk of inflation accelerating and re-basing itself at higher levels. What is clear is that supply and demand imbalances, heightened by disruption to transport and logistics, look set to continue into 2022. Material price input cost inflation can therefore no longer be considered a short-term issue or ‘blip’.

The recent imbalances between supply and demand have reminded us that the global economy is fragile and finely balanced. If key ports are shut down there are very few workarounds, similarly if there are rapid changes in consumer preferences and industries take prolonged periods to adjust to this, it can create significant bottlenecks. It is these real world constraints (particularly when combined with a rapid increase in fiscal stimulus and money supply to keep demand elevated) that create inflation.

Against this backdrop, our inflationary forecasts have been upwardly revised across most regions in 2021. Our resultant weighted UK average indicates that tender price inflation will rise by an average of 2.5% this year – higher than our previous forecast of 2% in Q3 2021. The high levels of competition in the earlier part of 2021 meant that the rapidly rising input cost inflation wasn’t fully feeding through into tender prices. As workloads began to pick up and construction activity indicators went from strength to strength, bidding competition slackened and tender price inflation accelerated.

G&T expects many of the current issues and underlying causes of inflation to spill over into next year but anticipate that the rate of tender price inflation will begin to ease off as supply and demand begins to rebalance. Our 2022 UK average TPI forecast therefore drops by half a percentage point to 2% as the ongoing supply chain issues threaten to dent new work growth in the early part of the year. While falling key commodity prices are a good lead indicator of material price inflationary pressures easing in the medium-term, other pressures look set to take centre stage. An increasingly tight labour market and fierce competition to attract workers is likely to result in mounting wage pressures and translate into “stickier” inflation. Labour constraints are therefore likely to be the primary driver of inflation throughout 2022 and beyond.

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

While the revised UK gross domestic product figures pointed to a stronger growth than previously reported, it was not enough to claw its way back to its pre-pandemic size. GDP rose 5.5% in the second quarter (higher than the 4.8% previously estimated) but the economy was still around 3.3% smaller than it was in the quarter before the pandemic struck.

The fact that the economy had grown more quickly in the second quarter meant it had less spare capacity and was more prone to inflationary pressure. Faced with the twin headwinds of accelerating inflation and supply chain problems, lost output is unlikely to be recovered this year. With the Bank of England cutting their Q3 growth expectations to 2.1%, the recovery is far from secured. In fact, estimates are that the economy won’t reach its pre-pandemic size until mid-2022 while Bank of England governor Andrew Bailey has warned the recovery is facing "hard yards" ahead.

The Bank of England’s view is that price pressures will be transient. While acknowledging the current pressures being experienced, Andrew Bailey said, “demand will shift back from goods to services, global supply chains are likely to repair themselves, and many commodity prices have demonstrated mean reverting tendencies over time.” More pass-through to retail prices is expected and manufacturers' output prices are still rising rapidly. A lot rests on how quickly and effectively supply capacity is rebuilt.

Consumer price inflation made its biggest jump on record in August to 3.2% on an annual basis. The jump was caused by a slump in prices last year and while inflation is expected to climb higher (potentially above 4%) in the coming months, the ONS urged caution from reading too much into the price increase. Some of this is genuine (eg rising shipping and transport costs) but much of it is due to extensive discounting in 2020. Regardless, higher inflation will raise questions about tightening monetary policy and interest rate hikes to contain inflationary risks down the line.

Added to this is a sense of nervousness among policymakers about winding down state intervention and how ending the furlough scheme will impact on hiring and wages. Even if furloughed workers are re-absorbed into their old jobs, reducing unemployment and inactivity in the economy, we are still left with the issue of excess job vacancies. This will continue to push up wages in certain sectors where vacancies are already high. Average weekly earnings (AWE) across the whole economy rose by 8.3% in the latest three-month period to July compared to one year ago. While this number is somewhat distorted by a few temporary effects, including the use of the furlough scheme, labour shortages are contributing to faster underlying pay growth. However, these same shortages are impeding further output growth and, if they persist, will cause inflation to stay high.

An average of all new forecasts for the UK economy points to a GDP growth rate of 6.1% in 2021, followed by 5.5% in 2022. Most of this year’s growth will be front-loaded, coming from a strong expansion in activity in the first half of the year. Growth slowed to a crawl in July as the Delta variant and so-called ‘pingdemic’ impacted consumer spending. Since then, constraints on activity have grown. Shortages of labour and materials and supply chain disruptions intensified, acting as a drag on growth. Despite these growth headwinds, forecasters argue that the economic recovery remains on track.

Construction Output and New Orders

Data from the ONS showed construction output fell for a fourth consecutive month in July and was down by 5.1% compared to the same month in 2019, prior to the pandemic. The ONS suggested that the main reasons for the monthly decline were price increases and product shortages caused by supply chain problems.

Both new work and repair & maintenance output fell in July 2021, the former being 6.9% below what it was the same month in 2019, while the latter was down 1.6%. The monthly contraction was attributed to shortages of key materials such as timber and roof tiles. Consequently, output growth cooled in sectors requiring a lot of these materials, such as the residential sector.

On a quarterly basis output figures appear a little more positive. Q2 2021 construction output was marginally lower (-2.1%) than the same quarter in 2019 but since the peak of the pandemic in Q2 2020, output has grown quarter-on-quarter. Q3 output figures are set to put a stop to this growth trend as supply chain issues and price rises continue to worsen and increase.

Growing confidence had been feeding in to new order figures which grew by 17.6% in Q2 2021 compared to the previous quarter. In fact Q2 new order values were the highest they have been since Q3 2017 and were some 11.6% above the quarterly average over the last five years.

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New work in all apart from two sectors (public new housing and private industrial) expanded in Q2 suggesting the recovery to date is now fairly broad. New private industrial work may have dipped in Q2 but its growth over the last year has been staggering, outperforming all other sectors and growing by nearly 300% between Q2 2020 and Q2 2021.

Inflation and supply chain issues may dent both output and new order growth in the final half of the year. Our latest Main Contractor survey suggests that over the next 12 months the availability of materials and rising material prices are expected to have the biggest impacts on their businesses. However, this hasn’t dented their workload expectations for the same period with the majority expecting their workloads to see a ‘minor increase’.

A look at recent IHS Markit’s Construction PMI surveys shows that, although still expanding and remaining well above the long-run series average, total new work growth is tapering off and in August, growth eased to a five-month low. Despite this, the survey noted that greater confidence levels among clients and the resumption of projects following the lifting of COVID-19 restrictions were a key reason for rising new business intakes.

While the pipeline of work looks healthy and businesses are optimistic of the year-ahead outlook, if the ongoing supply chain disruption persists it will restrain purchasing activity and become increasingly difficult to complete some of the pipeline of work. The pace of output growth is already showing signs of easing because of these issues and if not resolved soon, new orders could suffer if clients decide to delay their projects and wait for input cost inflation to stabilise.