UK market intelligence: Stagnation to strength
Our UK Market Intelligence (UKMI) report for summer Q2 2023 explores how slowing new orders, low new work construction output and persistently high labour and material costs, set against a backdrop of ongoing inflation and supply chain contractions, are causing concern for the UK construction industry.
With UK GDP growing by 0.1 percent in Q4 2022 and by the same amount in the first quarter of 2023, the country has successfully avoided a recession. In response, both the Bank of England and the IMF have upgraded their forecasts for the UK’s economic prospects in the second half of the year.
But few in the construction industry are celebrating yet. Construction demand remains weak, credit conditions are challenging and contractor capacity is becoming increasingly strained.
Contraction seems to be on the horizon. While conditions are far from perfect, the current period nevertheless offers clients and their programme managers a valuable opportunity to take stock, recalibrate and identify new ways of tendering and managing projects more effectively.
Economic outlook: economic standstill
Despite managing to avoid a recession thus far, the UK economy is now mired in a period of stagnation. In the past four quarters, the Gross Domestic Product (GDP) has fluctuated within a narrow range, from a marginal growth rate of 0.1 percent to a slight contraction of -0.1 percent. It is worth noting that the only quarter with negative growth was Q3 2022, which is less than what is required to classify as a technical recession.
Looking ahead, the outlook for economic growth is mixed. While some analysis suggests a contraction in 2023, the consensus is that the country may avoid a technical recession.
In the 12-month period to April 2023, the Consumer Prices Index (CPI) recorded an 8.7 percent increase, lower than the 10.1 percent reported in March and below the peak of 11.1 percent recorded in October 2022. Although this decline is a step in the right direction, it fell short of market expectations of 8.4 percent. Despite the cooling in inflation, prices continue to rise.
Meanwhile core inflation, which excludes food and energy costs, increased by 0.6 percentage points, from 6.2 percent in March to 6.8 percent in April, its highest level since March 1992. This is more than three times higher than the Bank of England's target of 2.0 percent.
The bank has already warned that inflation levels are likely to remain high for an extended period, as the expected decrease in food prices is taking longer than anticipated, and the UK economy is suffering from a wage-price spiral.
Construction overview: progress reliant on repair and maintenance
Construction output increased in 2022. However, the performance during the initial months of 2023 has been mixed, raising concerns about the outlook for the remainder of the year. Leading indicators of demand are showing a downward trend, and the growth in the construction sector is primarily driven by repair and maintenance (R&M) projects, while new construction work still lags behind pre-pandemic levels.
Since the pandemic, private housing R&M has soared as people spend more time working from home. New regulations and government retrofit schemes, along with an increasing focus on sustainability, have also boosted demand for R&M work.
Tender price inflation forecast
While the outlook for the UK economy is expected to remain weak in the near term, construction output is likely to contract. The Construction Products Association (CPA) has revised down its projections for construction output growth, with its latest forecast suggesting a 6.4 percent decline in output for this year, followed by modest growth of 1.1 percent next year. The CPA previously foresaw a more modest 4.7 percent contraction for 2023.
The construction industry is currently navigating a challenging period, marked by a surge in insolvencies to levels not seen since the global financial crisis (GFC). Moreover, profit warnings are also on the rise, indicating further difficulties. According to EY-Parthenon, the peak of insolvencies is yet to come, as there is typically a nine- to 12-month lag between the peak in profit warnings and the peak in insolvencies.
These challenges are shrinking the capacity of the market as contractors become more risk-averse and adopt a more selective approach to the types of contracts they are willing to accept. This heightened selectivity is offsetting the easing pressures from cooling demand, adding pressure to tender prices, and compounding the overall difficulties faced by the industry.
The combination of reduced market capacity, heightened selectivity, and loan repayment difficulties further underscores the need for strategic planning, financial resilience, and targeted support to address the ongoing issues within the construction industry.
Our tender price inflation forecast for real estate has slightly increased, up to 3.7 percent in 2023 and 2.7 percent in 2024. However, our infrastructure tender price inflation forecast for 2023 stays at 5.5 percent, unchanged from the spring report, but our estimate for 2024 has been revised down to 4.5 percent.
After the government's announcements in the , several projects entered a resequencing phase and have been postponed. This has rattled pipelines of work at a time when overall demand in the construction industry is cooling off.
However, there are pockets of growth in UK infrastructure. Network Rail set out a new investment plan for the next five years. The next phase of HS2 will be tendered in Manchester in July, and defence remains a hotspot along with public sector education and health, data centres and logistics.
Procuring better to sidestep stagnation
Construction may have avoided a recession, but the prospect of an extended spell of weak demand, tight credit conditions and constrained contractor capacity is hardly cause for celebration.
While many in the industry are veterans of the boom-and-bust cycle, the more unfamiliar challenges posed by stagnation should not be underestimated.
And though the growing wave of contractor insolvencies poses significant project risk, clients and their programme managers should use this current period to take stock, reflect and implement new ways to tender and manage projects more effectively.
Read the full report to see more economic data and insight, and to find out more about tender conditions in the UK.