Tender price inflation forecast
Material prices easing but upward wage pressure continues
Investor confidence has been under strain due to concerns from financial factors, including a scarcity of tender opportunities and prolonged decision-making by clients, reflecting apprehensions about the broader economic landscape. According to the Q3 2023 Royal Institution of Chartered Surveyors (RICS) UK construction monitor, there has been a notable decline in investor sentiment, with a net balance of -10.0 percent of respondents reporting decreased activity in Q3 2023, marking the most unfavourable reading since the onset of the pandemic. While workload expectations for the next 12 months appear positive, there is a discernible downward trend, emphasising the cautious optimism prevalent among industry participants as they navigate the challenges posed by cost dynamics and insolvency rates.
Source: Royal Institute of Chartered Surveyors/Haver Analytics
Nevertheless, the construction industry has remained resilient, avoiding a recession despite decreasing demand and fewer new work opportunities to replace completed projects.
Some supply-side pressures are also moving in tandem with demand-side alleviation. The construction sector is experiencing a respite in cost pressures, attributed to the softening of shipping costs and a decline in natural gas import prices. Notably, crude oil, a pivotal determinant of construction costs, reached a trough at $71 per barrel in mid-June. The World Bank expects oil prices to fall to $81 in Q1 2024, after averaging $90 in Q4 2023. However, this relative stability does not account for the potential escalation of the conflict in the Middle East, which could drive the cost of energy-intensive construction materials and components up.
The escalation in construction materials price inflation is steadily easing, following surges triggered by increased energy and commodity prices after the outbreak of the conflict in Ukraine. The S&P GSCI index, which tracks 24 major raw materials, has fallen 4.0 percent since the beginning of the year, mainly due to a decline from the high levels seen in 2021 and 2022. After falling by 2.3 percent on an annual basis in August 2023, the Department for Business and Trade's 'All Work' material price index fell by a further 1.8 percent in September. The overall decline was primarily due to reductions in the prices of concrete reinforcing bars, fabricated structural steel, and imported wood.
As material prices ease, most input cost pressures are coming from the labour market. Construction wages in 2023 have been rising by an average of 5.0 percent compared to the previous year. However, the reduced investment in new projects and softening demand are gradually easing recruitment challenges in the industry. This trend is evidenced by falling construction job vacancies from the peak seen in September 2022. Additionally, a slight increase in unemployment has led to a narrower supply/demand balance.
Source: Office for National Statistics/Haver Analytics
The combination of lower material costs and a slightly less competitive labour market might offer welcome relief to contractors facing financial constraints. However, specialist contractors have been the most affected by the prevailing financial challenges. In October, Michael J Lonsdale, one of the UK’s largest M&E contractors, entered administration. In the same month, Vistry, a UK housebuilder, made headlines announcing jobs cut while reportedly requesting a 10.0 percent reduction in prices from its subcontractors, revisiting terms agreed upon under existing contracts. These instances underscore the broader financial strain affecting entities across different tiers and sectors of the construction industry.
What does this mean for our forecast?
The deflationary forces from falling demand are being counterbalanced by high-interest rates, elevated material prices, and shortages of skilled labour. As such, our tender price inflation forecast remains unchanged from the Autumn revision at a 3.7 percent increase for 2023 and a further increase of 2.7 percent in 2024. For the remainder of the forecast horizon, our projections remain closer to the long-run average.
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.
Housing, which is the biggest construction sector, is facing obstacles due to subdued demand, leading to cutbacks in new initiatives. However, some sectors - notably private commercial and office fit-outs - demonstrate resilience and heightened activity.
Investors' confidence waned during the first three quarters of the year due to mounting uncertainty, escalating inflation, a fifteen-year peak in interest rates and record-high construction insolvencies. Looking ahead anecdotal evidence suggests a shift in contractor sentiment, indicating that they are presently not actively seeking work for the upcoming 12 months. This change in approach is attributed to the delay or suspension of projects that were initially scheduled to commence this year but have been pushed toward the end of 2023 and into 2024. This pent-up demand is filling contractors’ order books adding some inflationary pressure for tender prices in 2024.
Materials prices remain high compared to pre-pandemic levels, but inflation pressures are easing. In addition, the European Union gas storage has exceeded the 80 percent target, reaching 95 percent capacity by 1 November, significantly reducing the risk of energy cost increases similar to those experienced last year. Energy prices in Europe are 60.0 percent lower than last year along with UK natural gas prices, which have seen a similar fall.
The labour market is gradually changing in response to the sluggish performance of the economy. While wages remain elevated, contributing to upward price pressures, there is a steady shift towards lower costs as the market cools and vacancies diminish, easing the strain on hiring skilled labour. The gap between nominal and real wages has been narrowing since peaking in October 2022, but, as of September 2023, real wages remain 6.6 percent lower than nominal wages. This transition suggests that the labour market is adjusting to the economic slowdown, albeit at a measured pace.
Insolvencies within the construction industry reached their peak in Q2 2023, and there is anecdotal evidence suggesting that the industry has weathered the most severe challenges. Companies within the sector have adapted to navigating persistent headwinds and are beginning to perceive signs of improvement, indicating a positive outlook and a potential recovery on the horizon. However, contractors remain risk averse aiming to mitigate cash flow exposure adding inflationary pressure to tender prices.
Source: Turner & Townsend survey
The Winter 2023 infrastructure forecast remains consistent with the previous revision. Anticipated trends indicate a projected rise in tender prices by approximately 5.5 percent throughout 2023, followed by an additional increase of 4.5 percent in 2024. Notably, infrastructure work is less affected by the business cycle, and exhibits greater stability in the short term.
The infrastructure sector grapples with a polarised market where certain segments experience notable surges in workload. Notably, sectors like aviation, water, environment, and power exhibit substantial upswings. For instance, water infrastructure is expected to see a near doubling of capital expenditure during the upcoming asset management plan period (AMP8), surpassing historical spending levels. Meanwhile, in the aviation sector, the increasing passenger volume is boosting the works for expansion and modernisation to comply with evolving regulatory standards.
From an input cost perspective, the infrastructure sector continues to grapple with price volatility in materials, plant, and equipment. While some downward adjustments have been observed, overall costs remain elevated. These downward pressures are being counterbalanced by the growing capacity constraints and workforce shortages, particularly in specialised areas, adding inflationary pressure from the labour side. As a consequence, cautiousness prevails within the supply chain regarding risk and exposure, leading to a reluctance to overstretch and take on risks that historically they may have done.
Concurrently, the infrastructure sector is facing mounting pressure from supply chain disruptions stemming from insolvencies, inflation, high-interest rates, and an overall climate of uncertainty. These factors are straining the infrastructure market in certain areas, posing significant challenges in securing prices and attracting supply chains to engage in these expanding sectors, adding to inflationary pressure on future projects.
The availability of credit insurance within the construction industry has tightened significantly in recent months, as insurers grapple with an increase in claims stemming from the sector. This surge in claims activity, partly attributable to the recent failures of a few Tier 1 contractors, has compelled insurers to scrutinise their construction portfolios more closely. This risk-averse approach has translated into a reluctance to provide new business terms for construction-related projects, as developers are witnessing a decline in insurance quotes.
Source: Turner & Townsend survey
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