How Bad Is Construction Inflation Going to Get?

UK inflation is set to hit 11% this autumn, the highest since the early 1980s. Fuelled by rocketing energy costs and supply constraints, inflation will eat into construction companies’ profitability.
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The UK construction industry, like the rest of the domestic economy, is facing some of the strongest inflationary headwinds in a generation. 

Fuelled by rising energy prices and factors relating to Russia’s February 2022 invasion of Ukraine, the latest data shows UK inflation—the increase in price of a basket of goods and materials as recorded by the Consumer Prices Index—was 9.1% for the 12 months to May 2022.  

And there’s worse to come. The Bank of England has predicted inflation is likely to hit 11% by the autumn. To put that in perspective, the last time inflation was in double figures was in 1981, when the UK economy was mired in a recession. 

According to the bank, as well as external forces, there is also increasing pressure on prices from developments at home. There are more job vacancies than there are people to fill them, the bank says, which means employers are having to offer higher wages to attract job applicants. Businesses are also charging more for their products, including construction sector suppliers. 

Double-digit price rises 

Inflationary pressures have been a part of the UK construction industry for some time. Figures published by the UK government suggest prices of construction materials in the first quarter of this year rose by more than twice the current rate of inflation.  

Reporting on the 21.9% increase, the Construction Products Association (CPA) said the main driving force for building materials inflation was materials destined for SMEs, while product manufacturers also reported an increase in energy and fuel costs across the board. 

Rebecca Larkin, the CPA’s senior economist, said inflation could be seen throughout the supply chain, starting with manufacturers’ input prices.  

“It is particularly acute for energy-intensive heavy side firms, whilst data from [the government] has shown year-on-year increases of over 20% in construction products and materials prices since August 2021. It is, therefore, no surprise that materials were the key driver of SME builders’ costs in the first quarter.” 

Weaker business confidence 

Evidence of how the current climate is affecting the construction industry was revealed in the latest S&P Global/CIPS UK Construction PMI

Around 71% of the S&P Global/CIPS survey panel reported higher purchasing prices in June, with only 1% signalling a reduction. S&P Global said the resulting index “signalled a rapid pace of cost inflation that was slightly faster than in May, albeit still below the survey record high seen in June 2021. Higher prices paid mostly reflected rising energy, fuel and transportation costs, according to survey respondents.” 

Tim Moore, economics director at S&P Global Market Intelligence, which compiles the survey, said construction companies “appear braced for a difficult second half of the year as new order growth and business activity expectations fell again in June, reflecting inflation concerns, higher interest rates and less favourable domestic economic conditions.”  

S&P Global and CIPS said weaker business confidence had been recorded for five months in a row, “largely reflecting subject growth expectations for the UK economy, alongside uncertainty about the impact of higher interest rates and escalating inflationary pressures.”  

When will construction inflation recede? 

So when might things get better, and what can the industry do to mitigate the impact of soaring construction cost inflation which will eat into the profitability of many firms? 

The Bank of England said it expects inflation to recede to around 2% within a couple of years, but that in the meantime construction companies need to deal with price hikes. 

Some firms are embracing new technology, investing in off-site manufacturing and modular building methods to ensure the delivery of their projects is more efficient. Others, particularly smaller firms, are looking to work more closely with their suppliers to control and manage inflation risk. 

Meanwhile, the Construction Leadership Council (CLC), the joint industry-government body charged with boosting innovation across the sector, has spelled out its plans to mitigate the impacts of inflation. 

The CLC’s plan includes developing market intelligence about risk hotspots; publishing guidance on price inflation indexation and commercial issues; preparing case studies on good practice in response to current inflation; running industry briefings on conflict avoidance; and researching long-term capacity loss from Ukraine, Russia and Belarus, and its impacts on the sector. 

Strong demand, for now 

Although things are gloomy now—and possibly for the immediate foreseeable future—longer term there are those in the industry who remain optimistic, but with a couple of caveats. 

Acknowledging the mounting cost pressures, in May the CPA revised its growth forecast for the sector down from 4.3% in the previous quarter to 2.8%. “Demand remains strong across the industry in the second quarter,” the CPA said, “and the current project pipeline suggests that this will support activity levels until at least the third quarter.” 

The CPA noted that prior to the conflict in Ukraine, UK construction was already facing issues such as labour and product availability issues.  

“The impact of these pressures, and of more general rising costs, on demand will vary considerably by sector.  

“Across the board the picture is one of positive market conditions in the short term with anticipation of tougher times ahead,” it argued. 

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