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Cloudy with a chance of pain

Brian Green

It's not quite as bad as the Beast from the East, but the forecast is far from spring-like

The release of January’s construction output figures arrived like a belated and sarcastic Happy New Year greeting. Output was down 3.4% in the month, the worst monthly fall in five years. To add insult to injured optimism, work in the previously buoyant housing market had plunged 9%.

Chart 1
Chart 1

The unusual scale of decline is clear in Chart 1. Normally you’d shrug it off, comforted that the data are always revised and nearly always upwardly. So, they probably overstate the fall and things are probably better than the release suggests.

But we don’t live in normal times. We haven’t since Brexit gobbled up the political agenda. Every twist and turn in economic data is touted as evidence of either the “utter folly” or “sound judgment” of voting to leave the EU, depending on which side of the argument it appears to favour. Data have been weaponised. The Brexit debate is an uncivil war – not well mannered, where even truth becomes a victim.

However, one thing both sides seem to broadly accept is that in the short term there will be uncertainty, until a deal is done, and we head to greener pastures or hell in a handcart, depending on your viewpoint. Uncertainty is not a friend to the construction sector.

Read between the lines

So how should we read this latest rather scary bit of data from the Office for National Statistics?

In trying to unpick what’s really going on and what it all means, the only way to proceed with any hope of retaining dignity in these febrile times is to stand back, put prejudgment as far back in your mind as possible and look dispassionately at the array of relevant facts available.

It’s probably best to start with the construction output figures themselves. First, the collapse of Carillion in mid-January is likely to have had some impact. How much is hard to gauge because of how the data are collected. But if the measures were precise, the impact would probably account for less than 1% of industry activity in that month. Even adjusting for this the drop is still large.

Secondly, these are estimates. They are only facts in as much as it is a fact that they represent the Office for National Statistics’ best estimate at the time of the size, shape and direction of travel of the construction industry. But they’re the best estimates we have, so as near to facts as we can get.

It is a fact that these data tend to be revised upward more than downward. So, the most recently published data tends to be a pessimistic take on what the series over time will eventually reveal.

Revisions, irritatingly, are part and parcel of statistics. When data arrives after publication it must be incorporated in later editions, so the picture changes. ONS is aware of the asymmetry in the revisions and is looking at ways to fix it.

This all means we can draw some comfort from a likelihood that the estimated fall in construction in January probably overstates the underlying trend.

Chart 2
Chart 2

But any relief that might bring should be contained. Chart 2 shows a downward dip in output is in keeping with the current trend. The impact of the January figure is smooth in this chart, which uses three-month averages to balance out the month-to-month bouncing in the data that comes with the volatile, heterogeneous, muddled even, construction industry.

It shrank, on the ONS count, in each of the last three quarters of 2017, which may seem a bit mad given that ONS also has annual construction output rising in 2017 by 5.1%. Statistics eh?

For those that can stomach an explanation, a huge surge in recorded growth in construction in late 2016 and early 2017 lifted the level at the start from which it has decline slightly. And, yes, this pattern has raised eyebrows. A story for another day.

Downward trajectory

Importantly, whatever the foibles of this data series, it clearly points downward. The industry is shrinking in the eyes of the ONS. Some may find this unlikely, their experience at odds with an industry in recession. Some may be suffering worse than the figures imply.

The truth about the path of the nation’s construction sector is hard to know with certainty, but there are ways to test whether the ONS figures fit with reality.

We can look at one relationship that holds quite well, the link between construction output and GDP (gross domestic product), which measures the activity in the wider economy. It shows that construction is highly sensitive to wider economic conditions. If GDP dips, construction dives. If GDP grows, construction races ahead.

A rule of thumb suggests that if the economy is growing at a rate under 5% over three years, construction is likely to be in recession. Economic growth has been more pallid since 2014 and most growth forecasts, which seem to put annual GDP growth at about 1.5% in 2018 and 2019, point to an economy heading towards that 5% marker this year. These forecasts pretty much echo those recently released by the Office for Budget Responsibility, which were spun politically as good news.

It’s not hard and fast, but the current level of economic growth is consistent with construction being in recession.

Chart 3
Chart 3

It is a point often made by opponents to Brexit that the UK has gone from the strongest economic growth of the G7 advanced nations in 2014 to one of the weakest in 2017 (Chart 3). If we measured in US dollars, accounting for depreciation in the pound, the UK would have slipped from top to bottom.

The world economy has advanced and is currently buzzing more than had been expected, judging by consecutive upward revisions made in the International Monetary Fund World Economic Outlook reports. Meanwhile the UK economy is slowing, with prospects worsening in the eyes of the IMF. In its January growth projections upgraded the Euro Zone over the next two years, while downgrading the UK, despite the uplift it would feel from expanding global growth.

Yes, the UK economic growth was slowing anyway after a (convenient some might say) 2014 pre-election surge. But it should also have felt an uplift from the unexpected blossoming of global growth.

For architects, particularly in large practices, surging activity overseas is great news. The UK has built a solid platform from which to reap good fortune when it taps the shoulder of global construction. There is, of course, one added complication – Brexit. We don’t know how it will change the rules of engagement in overseas markets and what might be the effect of losing a pool of EU talent on which to draw freely.

Chart 4
Chart 4

For all the conflicting messages, architects, if we take the figures at a national level, are broadly positive, as Chart 4 shows. But there is clearly skittishness when it comes to Brexit. We saw that in the plunge in expectations recorded in the RIBA Future Trends Survey when the referendum vote was counted. And the mood in London has remained markedly cooler since and is distinctly chilly.

London and beyond

The more positive mood outside London is likely to be linked to housing related work expanding outward from the capital as house prices rise and more householders invest in improving their homes. This type of work is easing off in London as house-price rises turn to house-price falls in some hitherto buoyant markets. Meanwhile any delaying or reconsidering of investment in buildings that has resulted from Brexit uncertainty, will be felt most acutely in the capital.

When we unpick what is driving the RIBA trends indicator, the positive scores over most of 2017 don’t necessarily conflict with construction activity being in decline, particularly not when we factor in the tendency for optimism bias in sentiment indicators.

Chart 5
Chart 5

The recently release official figures for new orders will do little to perk up the pessimistic in London.

Looking across Britain, if you take infrastructure out of the equation, orders for 2017 are down on a year ago. There’s a hint of more work in housing, 2017 orders are up 2% on 2016, and there’s a bit more in the small industrial sector. But the commercial and public new work entering the pipeline is looking shabby, as we see in Chart 5.

In London orders look bleak. Infrastructure is the only bonus package, with the release of HS2 contracts. But that’s long-term and not highly lucrative as a proportion of spend for architects.

Meanwhile, the figures highlight how London’s housing market is waning, orders down 22% in 2017 on a year before. The flip side is that the North is set for a more bountiful period, with housing orders rising strongly, while the South East seems to be sustaining growth. This goes some way to explaining why optimism among architects has been heading for the shires and northwards.

Chart 6
Chart 6

Looking the Markit/CIPS survey data and the view of Bank of England Agents (Chart 6) we clearly see the industry flirting with decline. The growth rate certainly is waning. But does it say recession? One thing to note about this type of information, it tends to come from those still in business, so there’s a tendency for optimism to be favoured over the pessimism – overstating the upside.

Chart 7
Chart 7

The RICS construction survey paints a slightly brighter picture, as we see in Chart 7. But as mentioned earlier, sentiment surveys tend to produce optimistic results. And we could turn to numerous other indicators, some of which would show positive others negative. Importantly, there’s nothing in the employment data that would clearly conflict with the ONS data.

Meanwhile, the Minerals Products Association data is worth considering as it covers basic materials used across construction. MPA’s figures cast doubt on the ONS estimate of an annual rise of 5.1% in 2017 – the figure that has raised many eyebrows – but tend to support the pattern of weakening workloads through the year, with sales down in the final quarter of 2017 compared to a year earlier.

So how bad is it?

Ultimately none of this really provides cast iron support for the idea that the industry dipped into recession as the ONS data suggests. It does tell us, however, that not all is hunky dory in construction and the more we look around the harder it seems even to find straws to clutch.

Chart 8
Chart 8

So how do the expert seers within the industry see the future? Not so good is the answer, if we take the views of the Construction Products Association, Experian and Hewes and Associates as illustrated in Chart 8. The future looks quite flat. The sting, however, is that if you take out infrastructure we’re on a downward slope.

So, to answer the question of what weight we should give to the ONS take on the first month of 2018. The figures might not be right, but the sentiment is not that wrong. We could be in for an uncomfortable year – and that’s before we take account of the fuller effects of Carillion and the debilitating snowfall generated by the Beast from the East.


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