The UK construction industry continues to grapple with uncertain demand, high construction and financing costs, as well as skilled labour shortages - a potential storm that is increasing financial pressure.
These pressures may pose viability challenges in the immediate future and exacerbate the recent trend of rising construction insolvencies – the effects of which are being increasingly felt up and down the supply chain. Any reduction in capacity could exacerbate the current inflationary pressures and pricing of risk offsetting the reduced demand. While smaller specialist contractors and subcontractors are evidently being hit the hardest, larger main contractors are also not immune. Recent high-profile collapses from the likes of Buckingham Group and M&E specialist contractor Michael J Lonsdale illustrate how financial pressures and their knock-on effects are impacting all.
Given the current pressures acting out in the market, it is unsurprising that new construction activity has softened, especially compared to 2022, which was an exceptionally strong year for UK construction growth. Some projects, driven by development appraisals and debt finance, are finding it difficult to proceed and commit to construction from a viability perspective. However, with interest rates looking like they may have now peaked and materials cost inflation softening, these stalled projects may become unstuck.
While the emerging picture may be one of declining construction activity overall, certain sectors remain robust, giving rise to a two-speed market. Commercial fit-out and refurbishment, life sciences and biotechnology, data centres, and even the industrial sector, continue to benefit from strong demand. However, weakness in the residential sector (which accounts for around 22% of total construction output in the UK) is acting as a significant drag on overall growth, and in 2023 the Construction Products Association expect the sector will make an outsized contribution to its forecasted 7% contraction in total output this year.
Softer client demand and reducing material prices have been balanced against rising labour costs in our latest set of forecasts. Our UK weighted average TPI forecast remains at 3.00%, but minor adjustments have been made to some UK regions. Our forecasts for 2024 (2.25%), 2025 (2.25%) and 2026 (2.5%) also remain unchanged from our previous (Q3 2023) TPI report.
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.
Insert Macro Economic graphs
A slowing UK economy and an unexpected dip in headline inflation in August has warranted the first pause in a cycle of interest rate rises going back to December 2021, according to the Bank of England.
The MPC held to its message that further monetary policy tightening would be necessary if there was evidence of more persistent inflationary pressures and repeated guidance that monetary policy would be “sufficiently restrictive for sufficiently long" to get inflation back to its 2% target from 6.7% in August. However, for many, 5.25% now marks the peak of the rate raising cycle.
One pressure the Monetary Policy Committee (MPC) intends to monitor closely moving forward is the UK labour market. Although there are some indications of it loosening (ie rising unemployment rates and falling vacancies), the labour market remains relatively tight. High wage growth across the economy has resulted in continued resilience in demand, feeding into domestic inflationary pressures. Further rapid wage growth could therefore indicate more persistent inflationary pressure, so the MPC will be keeping a keen eye on wage movements when setting the bank rate.
Recent upward pressure on energy and oil pricing due to uncertainty in the Middle East conflict and continued war in Ukraine will also be monitored closely by the bank, as these have the potential to further stoke inflation.
GDP grew by 0.2% in Q2 2023, but this is unlikely to change the current subdued growth outlook. The Bank of England expects the UK economy to remain near stagnation for the next two years as a result of the battle against inflation. The impact of past increases in the bank rate is expected to increasingly weaken demand, pushing the economy into a state of excess supply (or ‘economic slack’).
Despite making some progress in the battle against inflation, the UK is forecast to have the highest inflation rate among G7 nations, averaging 7.2% over 2023. However, there are also reasons to be hopeful. UK inflation will average 2.9% next year, according to OECD forecasts. It also transpires that after a recent ONS data revision, the UK was in fact among the fastest in the G7 to recover from the pandemic, with the IMF now suggesting that the UK will grow faster than Germany, France and Italy in the long term. Furthermore, consumer confidence has climbed to its highest point since January 2022, supported by strong wage growth and easing inflation. The same trends also helped retail sales rebound in August.
Of course, the UK construction industry is impacted by more than just consumer confidence and interest rates. Government spending is a key driver of activity with the National Infrastructure Programme stimulating growth and shoring up the UK economy. Although the infrastructure sector is sustaining its output growth momentum, the pipeline is susceptible to shifts in Government policy and its overarching strategy to reduce spending and long-term debt, particularly heading into a general election. Infrastructure new orders have been on a downward trend in recent quarters as the Government scales back and reschedules projects, cooling the pipelines of work and disrupting order books in the rail and road sectors especially. However, the water, aviation and energy sectors appear buoyant as we approach the start of the new asset management plan period (or ‘AMP8’).
Construction Output and New Orders
While contracting 0.5% in value terms in July 2023, UK construction output remained 8.4% above the five-year monthly average figure and 6.8% higher than before the pandemic hit in February 2020.
Monthly construction output has yo-yoed between modest growth and contraction in 2023, painting a far more unsettled picture compared to last year. While total output has now grown for seven consecutive quarters, the rate of growth is evidently easing. However, at the sector level, the picture is not as clear cut. While some sectors face real challenges, others have seen future pipeline opportunities grow as demand remains strong.
In July, the decrease in monthly output came solely from a 1.3% fall in repair and maintenance work, with new work increasing 0.1% on the month. Acting as a drag on both new work, repair and maintenance work was the continued slowdown in the private housing sector. Private new housing output was 12.1% lower on an annual basis in July – the biggest year-on-year contraction of all the construction sectors. Conversely, infrastructure, public new work and, to some extent, private commercial output growth has been robust.
Anecdotal evidence suggests heavy rainfall in July led to delays in planned work as the housing market also continued to slow down amid high interest rates and plummeting demand. Although interest rates show signs of stabilising and the rate of construction cost inflation is easing, the industry as a whole remains very volatile with the picture changing from month to month.
The Construction Products Association (CPA) downgraded its overall forecast for output growth in its Summer 2023 report, from -6.4% to -7% in 2023, before recovering slowly in 2024 with growth of just 0.7%. The drags on output growth mentioned in the latest set of forecasts include persistent inflation, hindering the UK economy and its growth prospects, interest rates staying higher for longer, higher borrowing and financing costs harming prospects for new construction activity (particularly housebuilding) and client investment plans.
Although technically indicating a recession for the industry in 2023, it’s worth remembering that the forecasted contraction follows a record year of output growth and that 2023 output volumes will still be broadly on par with 2021 volumes. As reflected in ONS data, the CPA’s downgraded 2023 forecast is primarily due to sharp falls in activity in the two largest construction sectors: private new housing and private housing repair, maintenance and improvement (RM&I).
New order growth – a measure of the value and volume of new orders received by main contractors – dropped significantly in Q2 2023, contracting by 7% and falling well below the five-year quarterly average. Excluding the pandemic period in 2020, new orders in the second quarter of the year fell to their lowest level since Q2 2012.
With slowing new work volumes putting contractor pipelines under increasing pressure, output growth in 2024 will likely be muted.