Construction Output Returns to Growth in September 2022

A MODEST increase in construction activity in September saw a return to growth after two months of falling output. However, subdued demand persisted with the weakest trend for new orders since the recovery began in June 2020.

Confidence in the business outlook dropped to its lowest for over two years in September. This mostly reflects concerns about higher interest rates and a downturn in the wider UK economy. On a more positive note, supply shortages eased, with delivery delays the least widespread since February 2020.

The headline seasonally adjusted S&P Global / CIPS UK Construction Purchasing Managers’ Index (PMI) measures month-on-month changes in total industry activity. At 52.3 in September, up from 49.2 in August, the Index registered above the 50.0 no-change value for the first time since June. The highest for three months, a modest increase in activity came from work on previously delayed projects.

Sector Performance

House building was the best-performing category in September (index at 52.9), with growth reaching a 5 month high. Commercial work increased only marginally (51.0), while civil engineering activity (49.6) fell for the third month in a row.

Survey respondents often commented on a strong pipeline of outstanding work, but incoming new orders remained relatively scarce in September. Latest data signalled that new business volumes were broadly unchanged. This represented the worst month for new orders for almost two-and-a-half years. Construction firms cited slow decision-making among clients and greater risk aversion due to inflation concerns, squeezed budgets and worries about the economic outlook.

Subdued client demand contributed to a marginal reduction in purchasing activity across the construction sector. Survey respondents also suggested that a turnaround in supplier performance had led to reduced inventory building. Latest data signalled the least marked lengthening of vendor lead times since the pandemic began.

Meanwhile, employment growth accelerated from August’s 17-month low. Around 21% of the survey panel reported a rise in staffing levels, while only 8% signalled a decline. Higher workforce numbers reflected efforts to boost business capacity, although construction firms continued to cite shortages of candidates to fill vacancies and strong wage pressures.

Energy Costs

Average cost burdens increased sharply in September, but the overall rate of inflation eased to its lowest since February 2021. Survey respondents noted escalating energy costs and greater prices paid across the board for construction products and materials. Lower fuel prices and improved transportation availability are cited as factors helping to moderate the overall pace of cost inflation in September.

Finally, business optimism for the coming 12 months is relatively subdued in September. The latest survey pointed to the weakest growth projections since July 2020. While construction firms often commented on expected growth due to forthcoming new projects, many also suggested that recession risks and higher interest rates had weighed on confidence.

COMMENTARY

Deepening Concerns

Tim Moore, Economics Director at S&P Global Market Intelligence

Tim Moore, Economics Director at S&P Global Market Intelligence, said: “The return to growth was fuelled by delayed projects and easing supply shortages rather than a flurry of new orders.

“However, forward-looking survey indicators took another turn for the worse in September, with new business volumes stalling and output growth expectations for the year ahead now the lowest since July 2020. This reflected deepening concerns across the construction sector that rising interest rates, the energy crisis, and UK recession risks are all set to dampen client demand in the coming months.”

Pipeline Needed

Dr John Glen, Chief Economist at the Chartered Institute of Procurement & Supply (CIPS)

Dr John Glen, Chief Economist at the Chartered Institute of Procurement & Supply, said: “.

“Firstly, the rise in output has no sign of sustainable growth behind it as without new pipelines of work any gains will soon leak away. This was not lost on builders themselves who reported the lowest level of optimism since July 2020 about business opportunities in the next year.

“Secondly, the costs of doing business and the cost of living are still high and rising. More expensive energy and salary pressures to secure skilled staff have contributed to additional inflation, though 21% of building companies in the sector were still hiring to maintain capacity for current projects.

“The housing sector remained the strongest performer in September although with interest rates rising and mortgage costs affecting affordability rates especially for first-time buyers, this will be an obstacle for house building to keep up the momentum as we approach 2023.”

Clarity and Certainty

Brendan Sharkey, Head of Construction and Real Estate at MHA MacIntyre Hudson.

Brendan Sharkey, Head of Construction and Real Estate at MHA, said: “For the housing market, demand continues to remain strong however this will undoubtedly dip in the months ahead. The mortgage crisis following the Bank of England raising interest rates to 2.25% eliminates any economic benefits gained through the reduced stamp duty rate. Ultimately it creates zero incentive for homeowners to move or buy and potentially limits the ability and appetite of first time buyers from getting on the property ladder. Property prices should stabilise at best, but if employment falls expect to see falling prices.

“Last week’s mini-budget failed to produce any clear policies that provide additional support for the sector, meaning businesses face an uncertain future. The introduction of Investment Zones, while designed to stimulate economic activity and housing development within local economies, lacks sufficient detail on how the zones would work, the planning details required and the approval process. As a minimum the Government must address these points to enable the sector to fully grasp the opportunities it will present.

“The Government should reintroduce tax relief on mortgage interest for first-time buyers to stimulate the property market. This relief would run alongside the first-time buyers stamp duty reduction making an attractive incentive to both the buyer and developer. Ultimately, the Government must deliver their promises on time, without delays and with clarity to ensure that activity within the construction sector continues to flourish.”

Stephen Marcos Jones, CEO of ACE

More Reassurance

Stephen Marcos Jones, CEO of the Association for Consultancy and Engineering (ACE) said: “Given recent macro-economic events and movements in the financial markets, it will come as no surprise to see business optimism is struggling – it is clear that the coming weeks and months will be challenging.

“The survey reveals confidence in the pipeline, and we were pleased to see steps to expediate major infrastructure projects in the Chancellor’s recent fiscal statement, but it is increasingly evident that we need more reassurance for the sector in the form of an increase in new orders. Government and public sector clients need to lead by example.

Toby Banfield, Restructuring Partner at PwC

Cash Flow Challenges

Toby Banfield, Restructuring Partner at PwC said: 

“While the latest PMI shows sector growth and easing supply shortages in September, a deeper dive reveals ongoing pressure with the weakest trend for new orders since June 2020 and overall confidence dropping to its lowest for over two years. 

“Construction contracts are typically cash positive from a working capital perspective which means customers pay up front for various phases of work before the construction starts.  A drop in new project volumes reduces cash coming into the business, which is leading to cash flow challenges for businesses – a move that is increasing pressure with previous cash receipts already used to meet unexpected material price increases on existing projects.

“Getting costs under control, doing proper bottom up forecasts and locking in as many variable costs as possible, with hedging or inflation options will all be critical for managing cash flow going forwards. The manner in which firms react could make all the difference over the next few months.”

>> Read about August’s construction output report here