Introducing the Construction Industry Scenarios
On 24th June we all found out that the UK will be leaving the EU at some point in the near future. What we still don’t know is when, what our trading arrangements will be, whether labour mobility will be constrained, or whether negotiations over these major points will reach a quick or drawn-out conclusion. For us economists, this has raised the difficulty level for our Summer round of construction industry forecasts.
Given the cloud of uncertainty that now shrouds our economy, data on the pre-referendum months is all but redundant, whilst lagged release dates mean that economic data for the post-referendum months will only be drip-fed over the coming months. With this in mind, we’ve undertaken a scenarios analysis instead of our usual point estimate forecasts – laying out a central, upper and lower macroeconomic scenario that underpins the outlook for construction activity. In addition, the lack of information regarding the timing and impacts of Brexit on the UK economy and the construction sector mean that these scenarios cover 2016, 2017 and 2018, a shorter period than the CPA’s usual five-year forecast horizon.
In the CPA’s central scenario, total construction output is expected to increase 0.4% this year, fall 0.6% next year and rise 1.2% in 2018. Underpinning this, a noticeable downgrade from our Spring Forecast, is a slowdown in GDP growth and household consumption, and a fall in business investment in 2017, when uncertainty is expected to be heightened due to the likely triggering of Article 50.
It is sectors such as private housing, industrial factories and industrial warehouses that will be first to catch a cold, given the short lead times between market signals and project starts. The largest construction sector, commercial, and particularly offices and retail within it, will feel the impacts in 2017 as existing projects continue to completion while demand is shored up by pre-let agreements. The expected decline will be most acutely felt as speculative projects are put on hold amidst uncertainty and a deterioration in business confidence means firms are reluctant to sign up to new premises.
Inherent to the central scenario are key factors to consider and monitor, which may tip the performance of the economy and the construction industry towards a more bullish outcome – the upper scenario – or result in an outcome that is weaker than expected – the lower scenario.
Business confidence: The knock to business confidence and declining business investment could just be temporary before and immediately after the referendum. If confidence recovers quickly, economic activity will be less dented and businesses will feel more comfortable in investing in new office or retail space, or factories and warehouses.
Conversely, given the minimum two-year length of the EU exit process, uncertainty may linger. For instance, questions over trade, labour, regulations and passporting rules for financial services may see firms refrain from investing in staff, premises, plant and equipment, throughout the near-term horizon covered by the scenarios.
Consumer confidence: Household spending has been a key driver of economic growth since the recession. Early indicators have suggested a dip into negative territory immediately after the referendum. However, with the ‘leave’ vote winning on 52%, the majority of consumers could be unperturbed by the result and continue spending. Growth in high street spending, online sales and purchases of big-ticket items would shore up the key drivers of construction in the retail, warehouses and entertainment sub-sectors and signal confidence on house purchases and, therefore, new house building.
All of this relies on continued strength in the labour market and real wage growth, in spite of rising inflation. Indeed, an uptick in unemployment or redundancies could be the trigger that weakens consumer confidence. Propensity for discretionary, big-ticket spending will be key because if consumers’ willingness to spend on large purchases slides, then this would send a signal to house builders to reduce building, whilst overall weakness in consumer spending and confidence would lead to large declines in construction in the retail, warehouses and leisure and entertainment sub-sectors, as well as private housing rm&i.
Political uncertainty: The formation of a new government under Theresa May alleviated the political uncertainty seen immediately post-vote, but it will be how Westminster prioritises major infrastructure decisions alongside the progression of EU exit negotiations that will be important in creating a stable backdrop for investor confidence. Key projects that will either start or be approved under the central scenario include Hinkley Point C (start), HS2 (start), offshore wind (start) and South East airport expansion (to be approved). In previous Forecasts, downside risk to construction growth related to continual delays to EDF’s final investment decision for Hinkley. This has been exacerbated when Theresa May’s first major prime ministerial decision was to postpone the final government approvals and start of works.
Chopping and changing by government, in an already uncertain investment environment that has seen Siemens pause its investment into offshore wind, is likely to damage appetite for private and overseas investment into UK infrastructure. Therefore, the lower scenario has to envisage a case where Hinkley Point C, airport expansion and offshore wind are delayed beyond 2018, or even cancelled. HS2 is entirely publicly-funded (£55.7 billion) and such a high-cost project – already facing cost pressures, according to the National Audit Office – may also be delayed or cancelled if the expense cannot be justified in the event of an economic downturn.
Fiscal support: The upshot of a decrease in private investment or a delay or cancellation of major capital-funded projects like HS2, outlined in the lower scenario, is that it may be countered by fiscal spending on existing projects being brought forward from later years of long-term spending frameworks in the roads, rail and water and sewerage sub-sectors. The possibility of fiscal support also extends beyond infrastructure, to demand-side stimulus for private housing, i.e. to maintain or increase property transactions that underpin new build and rm&i work. It might also allow greater flexibility in the Affordable Homes Programme so that housing associations can react to weaker housing market conditions to provide affordable rent units, rather than market-linked shared ownership products that are susceptible to a slowdown in the housing market.
The amount of post-referendum data released in time for our Autumn publication will be just as scant, so we’ll be sticking with the Scenarios format in the short-term, until the underlying trends in the economy become a little clearer.