Growing pains

News that two members of the Bank of England’s Monetary Policy Committee (MPC) voted for an immediate rise in interest rates at the MPC’s August meeting has prompted renewed speculation that interest rates could start to rise during 2014. The decision is important to the growth plans of housebuilders, and anyone else reliant upon the general health of the UK economy – in other words, all of us.

Indeed, the Institute of Directors (IoD) has repeated its calls for an increase in rates before the end of 2014. Unlike many organisations, the IoD is keen to get monetary policy back to a normal position before the return of strong wage growth, which IoD members can already see is starting to build. The analysis in the August quarterly inflation report shows the degree to which the bank is taking into account a wide range of data, like July’s surprise fall in consumer price inflation (CPI). 

Construction is not a constituent part of the basket of data used to make up CPI, and the data describing the sector’s market conditions is neither as clear nor as representative as in other industries. However, with construction being challenged on so many fronts in its response to increased demand, perhaps MPC members would gain valuable insights by looking more closely at how our industry is performing.

I have recently completed a review of procurement trends in the private sector, speaking to colleagues, clients and contractors. The results of the review will have been sobering reading for clients across the UK. We found, for example, that the balance of power has shifted decisively towards specialist contractors in terms of their access to resources and pricing power, and that availability of operatives with the right grade of CSCS cards is contributing to labour constraints on individual projects, despite the presence of around 100,000 unemployed construction operatives. Both factors are clearly inflationary.

Even as the UK economy remains in intensive care, construction is facing growing pains - strains that point to short and long-term challenges

One key insight from our review concerns the speed at which the market shifted - projects that would have gained a lot of interest 12 months ago now have to be packaged carefully to secure a credible bid list. Another is that the experiences of contractors and clients in the current market don’t appear to be reflected in official data. Given how dependent the MPC is on data to determine interest rate policy, perhaps the experience of construction flags up a wider area of concern?

Take wages, for example. In the Bank of England’s August inflation report, forecasts for wage growth for 2014 were slashed by 50% and were cut back for 2015. Official data for earnings in construction, such as average weekly earnings data and national wage awards, would suggest that inflationary pressures are subdued, too - earlier this year Unite members agreed to two-year wage deals of about 3% per year for the building and plumbing trades. But with talk of strike action over pay by electricians, anecdotes of subcontractors poaching each other’s labour gangs and headlines about £100,000 pa brickies, it looks as if the construction workforce has inflationary expectations that are becoming harder to resist as the recovery consolidates. This risk highlights one of the bank’s key assumptions - that wage growth will remain consistent with the 2% inflation target. Could labour market conditions seen in construction spread more widely over the next year or so? 

Another assumption made by the bank is that sufficient slack remains in the economy - equivalent to 1% of GDP. Unemployment in construction now stands at about 4%, similar to many other sectors of the economy, but in our industry, the rate has halved in 12 months. It is the impact of shortages of specialist skills in key areas such as bid preparation as well as high levels of workload in trades such as bricklaying, which have resulted in capacity constraints and an inflationary spiral for sought-after skills.

So, even as the UK economy remains in intensive care, construction is facing growing pains - strains that point to short and long-term challenges for UK plc and for construction in particular. The first challenge is being able to anticipate change before it takes place. Construction businesses may have been anticipating a recovery for at least 12 months before it came in 2013, but were in no position to invest for the future given trading conditions at the time. Can other sectors take advantage of the wider recovery to invest for growth?

The second issue is the interconnectedness of business and the wider economy. Identifying the pinch points in supply chains that will constrain growth so that these risks can be mitigated will be critical - as can be seen in numerous projects that are being redesigned to avoid materials that are in short supply. Are there similar constraints in the complex supply chains of UK plc that haven’t been accounted for? The third challenge is one to which construction is particularly exposed - the challenge of low productivity, which is central to the Construction 2025 agenda.

Presently, UK construction is an outlier to the wider UK economy. It is growing faster, and, according to recent forecasts, has a strong pipeline of work. This positive prognosis is, however, threatened by a lack of capacity to deliver and an overwhelming dependence on the health of the wider UK economy to sustain levels of demand. While raised interest rates may have a short-term effect on the performance of the industry, the return of the economy to a healthy equilibrium is far more important for long-term prospects. Let us hope that lessons learned from construction over the past 12 months are taken into account as the UK moves into the next phase of its recovery.

Simon Rawlinson is head of strategic research and insight at EC Harris