Development Outlook Summer 2023: Macroeconomic drivers

What is the current state of the economy, and what is the outlook for the next few years?

Figure 1: HM Treasury Consensus Forecasts (July 2023)

Source: HM Treasury Consensus Forecasts (July 2023 for 2023-2024 and May 2023 for medium-term forecasts for 2025-2027). 

Figure 2: Market Indicators

Sources: ONS; S&P Global / CIPS; BCIS; OPEC; HMRC.

inflation

The UK (and global) economy is emerging from the biggest inflationary shock since the 1970s. CPI peaked at 11.1% in October 2022, and general price inflation remains elevated, with CPI still at 7.9% in June 2023. However, most forecasters expect inflation to slow significantly in the second half of this year. HM Treasury’s consensus forecasts (July) project CPI of 5.0% by Q4 this year before falling further towards the Bank of England’s 2% target rate in the following two years.   

The construction sector has been disproportionately affected by high inflation, with prices for many building materials accelerating faster than consumer prices. This can be attributed to supply chain disruptions, soaring energy costs associated with producing building materials, and a tight labour market pushing up wages in the sector. 

However, material cost inflation is now decelerating. Steel prices in particular saw a year-on-year increase of 64.5% in Q2 2022, but posted an annual fall of 27.1% in Q2 2023 after declining for four consecutive quarters (ONS). Price inflation for other inputs remains elevated but is also decelerating. Aggregates (including gravel, sand, clays and kaolin) rose by 23.1% in the year to Q4 2022, decelerating to 3.8% per annum by Q2 2023. Likewise, bricks and tiles increased by 40.2% per annum to Q4 2022, slowing to 22.7% in Q2 2023. 

In general, the backdrop of softening commodity price increases will ease pressure on total building costs. The effect, of course, will vary depending on construction type and the combination of materials used.

Figure 3: Material Costs

Sources: ONS; Carter Jonas.

cost of finance

The Bank of England increased the Bank Rate for the thirteenth time in a row in June to 5.0%, pushing the cost of borrowing to the highest level in 15 years. For businesses fuelled by financing, the inability to find cost-effective lending has discouraged borrowing, and increasing repayments on current loans has impacted cashflows and profitability. Recent inflation figures have been higher than expected, with core inflation accelerating to 7.1% in May before falling marginally to 6.9% in June. This underlines the scale of the challenge in bringing inflation under control and makes further Bank Rate rises likely. 

GDP

Economists have been raising their growth forecasts for 2023, and the consensus view now expects growth of +0.2% for 2023, compared with the -0.6% expected in March. The IMF has upgraded its 2023 forecast for the UK twice in quick succession, from -0.6% to -0.3% in April, and again to +0.4% in May. Whilst these upgrades are positive indicators, the overall picture remains one of very subdued economic performance this year. 2024 is expected to see somewhat stronger growth, although still below trend, at 0.7% (consensus view).

labour market

Figure 4:

Source: ONS

A tight labour market has constrained the construction industry’s ability to hire skilled workers and pushed wages upwards. Accelerated by Brexit and the pandemic, the construction workforce has shrunk 2.9% from its post-Global Financial Crisis peak in 2019 (see figure 4). At least partially as a consequence of this, construction job vacancies have remained stubbornly high, reaching record levels in 2022. Vacancies dropped by 17.0% from their peak to Q2 2023 as some firms re-assess their requirements or reduce employment to combat rising costs, but remain 65.7% above the 20-year average.

According to the CITB, 225,000 additional workers will be required by 2027 to meet UK construction demand. Experian, however, suggests that the construction industry will not achieve this, forecasting an increase of approximately 85,032 (or +3.7%) by the first quarter of 2027. This squeeze may drive the wider adoption of modern methods of construction. 

The imbalance of demand and supply in the labour market is also reflected in wage growth. In the three months to May 2023, average earnings in the construction sector were 6.0% higher than the same three months in 2022 (three month average, excluding bonuses; ONS). In May, the average wage was £705/week. Over a two-year period, average wages have grown by a notable 11.3%. With few signs that construction labour shortages will improve sufficiently, labour costs will continue to maintain upward pressure on tender prices.

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