Tender price inflation forecast
Despite falling demand, input cost pressures could keep increasing prices
According to the Office for National Statistics, in Q2 2023, total construction new orders witnessed declines both on a quarterly and yearly basis, settling below pre-pandemic levels by 10.9 percent. Additionally, Glenigan's measure of construction project starts witnessed a significant decrease of 33.0 percent in June compared to the same period of the previous year. Furthermore, the Construction Product Association (CPA) projects a challenging outlook for construction output. An anticipated contraction of 7.0 percent is forecasted for 2023, followed by a gradual recovery of 0.7 percent growth in 2024. This downturn is largely attributed to substantial decreases in two pivotal construction sectors - private housing and infrastructure.
New orders for private housing are currently 11.7 percent lower than the levels recorded in the pre-pandemic period of Q4 2019. The expansion of investments in housing is facing obstacles due to the rise in mortgage rates, pressures in household finances and the end of the Help to Buy scheme in March. In spite of this, private housing new orders increased by 3.6 percent on the quarter but decreased by 14.9 percent on the year.
Infrastructure new orders have been on a downward trend since the recent peak in Q3 2022. In Q2 2023, there was a significant decline of 26.4 percent in infrastructure new orders compared to the previous quarter and a substantial decrease of 42.9 percent compared to the same period last year. This contraction is largely due to reductions in sewerage, roads, and harbour projects, which experienced declines of 88.4, 77.7 and 54.2 percent, respectively, in comparison to the same quarter last year.
Nevertheless, amidst these challenges, there are certain areas experiencing growth. Notably, new orders in the private commercial sector are ascending, primarily driven by increased investments in education, shops, and office spaces, all of which have exceeded their pre-pandemic levels by 82.1, 25.5 and 16.9 percent, respectively.
Figure 4:
Construction new orders, last 20 years performance, index value 2019 Q4 = 100
The construction industry is grappling not only with reduced demand but also with persistent inflationary pressures on tender prices driven by escalating input costs.
In June 2023, construction materials prices decreased by 2.0 percent compared to the same month in the previous year. Although this is a notable decrease from the peak of 26.8 percent observed in June 2022, materials prices remain elevated, standing at 42.3 percent above the levels of February 2020, before the pandemic, and 11.6 percent higher than February 2022, prior to the start of the conflict in Ukraine.
Source: Building Cost Information Service
A notable contrast is observed in construction sector wages, growing by 5.5 percent in June 2023 compared to the corresponding period in the previous year. Furthermore, the pace of wage growth has surpassed that of construction materials. Figure 5 shows the difference in the month-on-month change in materials prices and labour costs. This suggests that inflationary pressures originating from the labour market are becoming more prominent. This situation has not been witnessed since October 2020, indicating an important shift in the inflationary landscape.
The construction industry is currently confronting a combination of factors, including cost inflation, high-interest rates, escalating material prices, and skilled labour shortages. These factors have driven the surge in insolvencies within the sector, reaching the highest count ever recorded since the inception of the measure in Q1 2010.
The impact of insolvencies is being felt in the market, with specific sectors experiencing more pronounced effects than others. The prolonged duration of challenging financial and economic conditions has led contractors to be more risk-averse, particularly on bigger projects.
Source: Insolvency Service
In contrast, the decreasing demand has triggered a certain level of capacity within the market. However, contractors are keen to bid for more simple projects. This strategic shift is driven by the aim to mitigate cash flow exposure and distribute risks in collaboration with clients.
The evolving landscape suggests a delicate equilibrium between risk aversion and strategic management in response to prevailing market conditions. As the construction industry navigates through these challenges, adaptability and a nuanced understanding of market dynamics become imperative for sustained success.
What does this mean for our forecast?
Our central scenario estimates that real estate tender price inflation will increase by 3.7 and 2.7 percent in 2023 and 2024, respectively, remaining unchanged from the summer revision. Our forecasts for 2025, 2026 and 2027 have been revised down to 3.0, 3.5 and 3.5 percent, respectively.
Figure 7:
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.
While the construction industry appears to be heading towards a potential recession (defined as two consecutive quarters of falling output), the assumption that tender price inflation will decrease alongside dwindling client demand is not straightforward. However, the dynamics are more complex due to inflationary pressures stemming from input costs that are counterbalancing the deflationary forces.
Material prices remain elevated, surpassing levels seen prior to the pandemic and the conflict in Ukraine. Furthermore, inflationary pressures from the labour sector are becoming more pronounced. Despite nominal wage increases, these have failed to match the rate of consumer price inflation, intensifying pressures as the demand for higher wage increments extends across the industry.
Inflationary pressures are also being exacerbated by reduced capacity resulting from increased levels of insolvencies. Specialist contractors and subcontractors have been affected the most, but the recent collapse of Buckingham Group, a company involved in significant projects such as HS2 and the Anfield football stadium in Liverpool, is a stark illustration of the magnitude of challenges currently confronting the construction industry across the board.
Source: Turner & Townsend Survey
Our infrastructure tender price inflation forecast remains unchanged from the summer revision. Infrastructure tender prices are expected to increase by 5.5 and 4.5 percent in 2023 and 2024, respectively, and at a yearly rate of 5.0 percent between 2025 and 2027.
Inflation pressures are mixed in the infrastructure sector. While the rescheduling of some projects is cooling the pipelines of work, especially in the rail and road sectors, there are considerable growth areas being seen in other sectors.
The water, environmental resilience, aviation and energy sectors are particularly buoyant with the upcoming start of the new asset management plan period (AMP8), the continued increase in passenger numbers post-COVID-19 and the need to invest in renewable energy.
A notable example, part of the Strategic Resource Options (SRO), is the 205 mile, £500m pipeline from Humberside to south Essex and two reservoirs that Anglian Water is planning to build. On the energy sector, the recent allocation of £170m to the Sizewell C project is providing support for preliminary work, procurement of essential components, and the expansion of its workforce.
However, the infrastructure sector as a whole is grappling with a decline in demand, compounded by Government decisions to delay projects like HS2 and the Lower Thames Crossing while stopping work on the HS2 terminal at Euston station in central London. These delays are causing disruptions to the supply chain's order books.
In this scenario, clients must focus on enhancing their appeal to the supply chain, work together and share risks. Failure to do so could result in project and programme setbacks, underscoring the need for effective collaboration to ensure timely and successful project completion.
Source: Turner & Townsend Survey
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