Continuously shifting data is helping to disguise an industry already in recession
The next release of construction monthly output data from the Office for National Statistics is highly likely to show that the industry has fallen into recession.
The data just released shows activity in the first two months of the second quarter both below the average monthly figure in the first quarter. It would take substantial upward revisions, or the data showing activity surging in September, to avoid a second consecutive quarterly fall. That would mean construction is already technically in recession.
Technical recessions are not necessarily an overworrisome thing in an industry as volatile as construction. The industry dipped in and out of recession in 2011 and 2012 without too much clamour, as it clawed its way back from its nadir in 2009. And no one is currently predicting a deep decline.
But the recent statistics reflect how the construction industry, which relies heavily for support on confidence and growth in the wider economy, is currently teetering uncomfortably. Chart 1 shows the steady dip in the official output figures that began early this year.
These data are not hard and fast, shifting continuously. But hoping things are better than they seem in the data seems highly optimistic: the fall is unlikely to be washed away by revisions. Similarly, pinning hope on a surge in September output also seems a bit desperate.
The Markit/CIPS construction indicator for that month showed a sharp fall in activity (Chart 2). This indicator tends, if anything, to run rather on the optimistic side. So, the drop from 51.1 (comfortably above the 50 no-change mark) to 48.1 (the lowest point since the EU referendum shock) created a bit of a shiver in the construction data-watching community.
The question is what is coming through the pipeline that might push the industry back into growth. The answer, on current data, is not a jolly one. The latest new orders figures (Chart 3) show work won by contractors falling in the second quarter. The level was the lowest for three years.
Naturally the connection between orders won and work on site is not direct as the flow derived from the stock of orders is far from even, with project lengths varying greatly. But the figures do tend to provide an early indicator of both confidence in investment and likely future work. And the latest figures provide little comfort.
The total orders figures for all new work has fallen since the second half of 2016. The worst of the falls in the quarter were in London and the East of England.
With austerity a continuing feature of the UK economy, it is little surprise that there has been a slump in orders for public non-housing work. There was 17% less work let in the first half of 2017 than a year earlier. But, importantly, private commercial appears to have taken a hit, notably in London. Work let in the sector across the UK in the first half of this year was 12% below the same period in 2016. Despite construction orders in new housing still growing, the decline in the overall level of work won was 5% comparing the first half of 2017 with 2016.
On the positive side, we can expect to see a leap in new orders next quarter as £6.6 billion of HS2 contracts feed into contractors’ order books. But these are large long-term contracts. Yes, it will be good for construction activity, but the figures themselves may well disguise creeping weaknesses elsewhere in the figures.
There may be plenty of ready reasons one could pull from the shelf to convince yourself that this fall is temporary, but the truth is that it is just one more sign among many of the fragile market in which UK-based construction firms are currently operating, with high levels of uncertainty and low levels of economic growth.
Uncertainty, that familiar word these days, is not the friend of the industry. Construction assets are long-term big-ticket items and, as we all know from our own experiences, it doesn’t take much of a dip in confidence to put off a decision to splash out when you can make do without for a while.
Construction growth is also very sensitive to changes in wider economic performance. The general trend seems to be that if gross domestic product grows by about 6% or more over a three-year period then construction sees growth. If economic growth is higher, construction accelerates. If growth is lower, then the chances are that construction will slump over the period.
There’s no hard and fast rule, but economic growth provides a very strong indicator of construction activity. And, as things stand, we appear to be sitting uneasily on the edge separating growth and decline in construction activity. The economy has grown by close to 6% over the past three years, but the growth rate is declining. What’s more unsettling is that the consensus of forecasters’ expectations for economic growth over the medium term (up to 2021) have been downgraded over the summer.
Between the June and August issues of HM Treasury’s comparison of independent forecasts, the average growth forecasts for each year 2017 to 2021 has been shaved by 0.1% to 0.2%. This may not sound a lot but the cumulative impact is significant, given the sensitivity of construction to GDP growth. As they stand, forecasts suggest that the economy is unlikely to generate that magic 6% three-year growth rate.
The picture so far given by various trade surveys seems to be far from doom and gloom, although they may suggest the need for caution. Certainly, the overall mood among architects, as measured by the latest RIBA Future Trends Survey (Chart 4), seems mildly positive. It shows expectations of future work positive and the mood suggests an expansion in staff over the next few months.
Dig a bit deeper, though, and we see that pattern is not even across the country. London, which in many ways is the mother lode of UK architects, has dipped into pessimistic territory over the summer – from a +17 balance of practices expecting more work in April to -6 in August. Clearly experiences among architects vary, which is what one would expect in a fragile, uncertain market.
A further unsettling indicator is the ONS measure of producer price inflation for architectural services (Chart 5). Getting hard and fast figures for price changes in services is not easy, but the data will at least be indicative. They show that having managed to push up fees both in nominal and real terms since late 2014, practices saw no rise in fees in nominal terms in the second quarter. This means a real-term decline when accounting for inflation.
This could be down to higher productivity. In which case that’s a good thing. It may also be the effect of a shift in overall fees from more expensive London practices to lower cost practices elsewhere. It may be caused by a subtle shift in the mix of work not picked up by the methodology of the ONS. But whatever the cause it is a reason for concern.
More Jackson Pollock than John Constable, the picture of construction that emerges is one of dynamic change and unpredictability. But the mood developing, as more texture is added, is tending towards darkness rather than light for construction.
Looking to the middle distance, there are many more barriers that may inhibit construction growth apparent than there are obvious drivers to promote it. This will be frustrating for those who appreciate the pressing need for a better built environment. Their frustration heightened by the cost of construction being well recognised, while the value is far less appreciated and understood.
Brexit aside, construction and a better built environment has a vital role in influencing the social and economic woes that are currently jostling to top the political agenda, be it better housing, better health, higher productivity or social mobility.
Furthermore, there is a clear and urgent need to foster confidence in the construction industry to prompt more homegrown talent into its ranks as the nation faces growing skills shortages and likely limitations on migrant workers.