Tender price inflation forecast
Lessons from past recessions
Recessions often cause a deceleration of tender price growth that can then trigger deflation.
Over the last 50 years, there have been just six years of deflation within the construction industry, all of which followed periods of UK-wide recession.
With the BoE forecasting that the UK economy is likely to experience a recession, the pathway for tender price inflation will inevitably be impacted.
Source: Building Cost Information Service, Turner & Townsend
Based on the response of industry pricing to previous recessions, there are reasonable grounds to expect a fall in tender price inflation. At what point prices change, how much they fall by, and how long the slowdown endures, is a more complex matter – see Figure 3.
Two recessions prompted deflationary pricing immediately after the onset of their respective GDP contraction, during the 1990s and 2000s. However, the deflation which followed the 1980s and COVID-19 recessions was lagged, by 18 and nine months respectively.
From peak to trough, tender price inflation fell by 10.6, 23.2, 16.7 and 2.1 percent in the 1980s, 1990s, 2000s and COVID-19 recessions respectively. On average, tender prices fell by 13.2 percent.
The duration of the deflationary periods ranged from just over a year, following the 1980s and COVID-19 recessions, to 18 months for the 1990s recession.
Momentum also has a part to play. All but the 1980s recession saw tender price growth slow prior to the onset of GDP reduction. Those downturns with the greatest deceleration – the 1990s and 2000s – saw tender prices fall further for longer – see Figure 4.
Source: Building Cost Information Service, Turner & Townsend
While looking back at the dynamics of construction pricing in the wake of past recessions can help us understand previous patterns, it’s by no means a predictor of future events.
Each recession was brought about by a unique set of circumstances that are unlikely to be repeated in the same combination.
The 1980s and 1990s recessions were linked to business cycles and government policy decisions. The Global Financial Crisis, a balance sheet recession, hit in the 2000s. Most recently, the COVID-19 recession was caused by the pandemic, significant global lockdowns, and supply shocks, which ultimately fed into a reduction in demand.
Since then, the UK economy has evolved and adapted well to the legacy of COVID-19. However, shockwaves from the war in Ukraine, rapidly rising interest rates and inflation have hampered growth. Coupled with a sharp slide in sterling and falling business confidence, GDP may now well end up in contraction territory.
The 1970s recession is perhaps a closer reflection in comparison to recent performance. The 1973 oil price crash led the contraction, along with an energy shortage, stubbornly high inflation – enhanced by wage bargaining of unions – and uncoordinated monetary policy. The net effect was stagflation, which is a troublesome combination of stagnation (low growth and high unemployment) and high inflation.
Despite exhibiting a few similar characteristics, the current market is unlikely to confront a 1970s redux. Inflation has been much lower, for longer, in the run up to this inflationary surge, and the BoE now has a mandate to set prudent monetary policy to curb inflation.
There is also a reduced likelihood of the current inflationary pressure morphing into a wage price spiral, given the lower bargaining power of unions. The inflationary impact of high oil prices has also moderated as the UK has reduced its dependence on oil.
The threat of stagflation, however, does pose a risk. Though the ‘textbook’ definition of stagflation has not yet been reached, either in the construction sector or across the economy as a whole, there are growing signs of it emerging.
Tender prices are high. The Building Cost Information Service’s quarterly Tender Price Index figures suggest that industry pricing is estimated at 9.0 percent on the year as of Q2 2022 – see Figure 5.
Source: Office for National Statistics and Building Cost Information Service
Construction output has been resilient, rising in Q2 2022 by 2.3 percent on the quarter. Still, the rate of growth is set to slow. The Construction Products Association’s summer forecast, released in July, predicts that construction output will grow by just 1.6 and 2.5 percent in 2023 and 2024, respectively.
The Government’s Growth Plan, announced at the end of September, includes several measures that should give the industry a shot in the arm. In addition to bringing forward investment in infrastructure, there were plans to create 38 Investment Zones across England, which would offer liberalised planning rules to release more land for housing and commercial development.
Yet these glimmers of optimism should be weighed against the tightness of the labour market. Although the current low unemployment rate could prevent a ‘dictionary definition’ period of stagflation, the reality is that UK construction is facing a serious skills shortage, stemming in part from an exodus from the workforce during Brexit and the pandemic. This shortage adds upward pressure to labour costs, further impacting inflation and potentially hindering the sector’s output growth.
So, while economic activity and construction output growth may slow – or even fall – inflation may remain elevated.
What does this mean for our forecast?
Our central scenario estimates that real estate tender price inflation will increase by 9.0 percent in 2022 on average. This is 0.3 percentage points higher than our Summer 2022 forecast. We have revised our forecast for 2023, reducing our inflation expectations by 0.3 percentage points, moving from 3.8 to 3.5 percent. The remainder of the forecast horizon has been left unaltered.
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.
Despite much of 2022’s inflationary uplift in the first half of the year, inflationary pressure is still being felt as we approach the end of the year.
Moving into 2023, tender price inflation is likely to be more moderate, helped by weakening demand, supply chain recalibration and fiscal policy alterations. And whilst material cost may remain elevated – reinforced by growing energy costs - increased production costs are now less likely to be successfully passed through the supply chain.
This has been seen recently in British Steel hikes, with increased pricing not sticking as demand softens and fabricators are not willing to pay the proposed premium.
Even though there is a plausible chance for a recession in the UK, prices aren’t expected to fall based on current thinking. Reduced demand will continue to place downward pressure on inflation in 2023, yet the emergence of stagflation may contribute to the UK construction industry avoiding negative pricing. 2024, however, is more at risk of deflation as industry momentum could fade, depending on the length and severity of any potential recession.
Nevertheless, the UK market is less stable than it once was, and regular reviews of pricing expectations will be needed as time elapses and further market volatility unfolds.
Source: Turner & Townsend Survey
Our infrastructure tender price inflation forecast has also changed. Our summer 2022 forecast anticipated a possible 8.0 percent increase in 2022 and that has now been revised to 9.0 percent, up by 1.0 percentage points.
The Government’s plan to pledge fast-track spending on road, rail and energy infrastructure should accelerate programmes and reinforce committed expenditure. This is likely to stabilise demand, restrict deflation prospects and keep infrastructure pricing above that of real estate moving into 2023 and 2024.
Source: Turner & Townsend Survey
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