Tender price inflation forecast
Despite softening demand, construction costs remain stubbornly high
With the UK in a recession, it is tempting to look back at previous downturns to see how the economy might perform over the year. However, in some areas of the economy, the current downturn continues to defy economic logic. While construction demand fell sharply in the last quarter and unemployment and redundancies did pick up, albeit still at low levels, and annual wage growth is still strong. Vacancy levels are still above their pre-pandemic levels and skill shortages in specific areas remain acute.
Since peaking in July 2022, the Department for Business and Trade's 'All Work' material price index has fallen by 5.8 percent. Material prices remain 37.8 percent above their pre-pandemic level of Q4 2019.
Energy prices have so far shrugged off disruptions to shipping in the Red Sea and the risk of wider conflict in the Middle East. If energy production continues to be largely unaffected, some economists expect most prices to fall further by the end of the year.
Energy prices have not only stabilised, but they also fell considerably during 2023, due to the impact of global monetary tightening on world activity levels and commodity prices. Higher borrowing costs have weighed on investment in interest-sensitive sectors, such as construction, housebuilding, mechanical engineering, industrial & building materials, and metal products.
The Red Sea crisis has continued since last November, and the ongoing interruption and delays to global shipping are likely to push up the cost of imported materials even further in the coming months.
Source: Department for Business and Trade
In December, average weekly earnings in construction grew by three percent compared to November. This helped push the annual rate to 6.1 percent, from 3.5 percent in November. After adjusting for inflation, real income growth in construction was 2.1 percent in December. Weak new orders in 2023 should mean pay growth starts to moderate in the coming months.
After a drop in 2023 Q3 the number of sector insolvencies was up again from 1,061 companies to 1,195 in Q4 – close to the record set in the second quarter. The impact of insolvencies is being felt in the market, with specific sectors experiencing more pronounced effects than others. Sectors such as residential and non-residential buildings mechanical, electrical and plumbing have been particularly hit whereas construction in utilities and civil engineering are largely unimpacted.
Contractors continue to face a multiple number of financial and logistical challenges from elevated input costs, high borrowing rates and labour shortages. But there are also increased cost pressures in specific areas like sprinklers, mechanical and electrical, security, fire alarms, specialist mechanical and electrical fitters, and brickwork.
Although demand is softening, construction companies remain relatively positive in their outlook. We have already seen this in the February 2024 S&P Global UK Construction PMI. The Q4 2023 Royal Institution of Chartered Surveyors (RICS) UK Construction Monitor is relatively less pessimistic than in Q3, a sentiment based on the prospect of falling interest rates over the course of the coming year.
The net balance for workloads, which captures total activity for the whole of the construction industry eased to -8 in Q4 from -10 in Q3, although modest it nonetheless is in the direction. By sector, infrastructure remains the most buoyant, though this measure has eased since Q2. and unsurprisingly housing is the worst performer.
Financial constraints remain a concern for two-thirds of the RICS survey respondents because of high loan rates and access to credits. That said, with rates expected to fall the sentiment was less negative in Q4 2023 than at any time since mid-2022.
What does this mean for our forecast?
With new orders falling in Q4 2023, and the economy in a technical recession, in our central case forecast we have real estate TPI slowing to 3.2 percent in 2024, from 3.7 percent in 2023 and 9.5 percent in 2022.
For the remainder of the forecast horizon, our projections remain closer to the long-run average.
The Spring 2024 infrastructure forecast remains consistent with our previous forecast update. Our central TPI infrastructure forecast is still 4.5 percent in 2024 down from 5.5 percent in 2023. Notably, infrastructure work is less affected by the business cycle and exhibits greater stability in the short term.
Figure 6:
Tender price inflation: annual percentage changes
Source: Turner & Townsend survey
Our forecasts are representative for the UK as a whole and inflation may vary by project size, value, procurement route and region. Projects need to be assessed on an individual basis and may not always align to our central scenarios. For further assistance on cost assurance and inflation analysis in your area, please contact Turner & Townsend.
Although material prices have fallen since peaking in mid-2022 they have only contracted by under 6 percent, whilst construction annual wage inflation is still strong at over 6 percent. With further moderation expected with these two inputs we forecast real estate TPI to ease to three percent in 2025 and then pick up to 3.5 percent in 2026 as cuts in the Bank Rate start to provide stimulus to economy.
Private house-building activity has been weak since Q2 2022 as mortgage rates have soared, but with lower borrowing rates expected in the future this should help revive the housing market.
Source: Turner & Townsend survey
Despite the weakness in infrastructure new orders for much of the past year, the outlook over the forecast horizon looks positive with several projects potentially in the pipeline. One of the largest is the Asset Management Period 8 (AMP8) in 2025 affecting all English and Welsh water companies. Proposals would see £96bn investment in the period, an 88 percent increase from AMP7, to fund new reservoirs, upgrade pipes and clean waterways.
Network Rail is set to allocate a large pot to renewing core assets like track, structures and earthworks to keep trains moving during adverse weather conditions, with a planned spending of around £44.1bn during the Control Period 7.
In addition, the Chancellor confirmed in the Spring Budget that the £160m purchase of two nuclear sites from Hitachi, Wylfa in Anglesey and Oldbury in South Gloucestershire, would go ahead.
The Government has also given a welcome green light to the next section of East West Rail, accelerating works from Oxford to Bedford.
Major programmes like this would benefit from a similar approach to that seen in areas like life sciences, advanced manufacturing, and nuclear power. In these sectors, clear ambitions are set out and stuck to, and the Government can play more of an enabling role in stimulating private investment, rather than relying on funding from public sources.
Like the rest of construction, the infrastructure sector is also facing pressure from supply chain disruptions as insolvencies rise and inflation and high interest rates are making projects even more expensive. Infrastructure not only faces uncertainty regarding planning applications but also the outcome of the next election where a new government may well have different priorities.
Source: Turner & Townsend survey
Contractors are also facing challenges in securing performance bonds, with some limiting their exposure or withdrawing from the market entirely. Investor pressures, such as high-interest rates, inflation, low end-user demand, and an upcoming general election, have forced some investors to pause construction schemes. Insolvency risks are also a concern for supply chain managers and tender list compilers.
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