Industry experts cautiously optimistic about 2006

Predictions can be dangerous.

This time last year, market experts forecast that private sector spending would fall, but that this would be offset by generous public sector investment. The Construction Products Association estimated that public sector spending, including the PFI, would rise about 4%, a finding that was supported by economic consultant Experian.

In reality the early indications for 2005 suggest that public sector spending actually fell almost 3%. The CPA says this decline knocked 1.3% off the industry’s total output in 2005. This was the first contraction in the industry since 1994 and ended the longest period of growth since the 1950s.

But will the situation improve in 2006? Building spoke to the CPA, Experian and other industry experts who tentatively forecast that it probably would – but that its fate was once more in the government’s hands.

Overall, the CPA has predicted that construction output (up) will rise 0.9% in 2006, compared with Experian’s forecast of 1.7%.

UK economy

Looking at the bigger picture, economic growth (up) in the UK is expected to rise steadily over the next three years. In the shorter term, the government lowered its forecast for growth in the pre-Budget report in December. Britain’s GDP (up) is now forecast to rise from 1.7% last year to 2% this.

The Bank of England left interest rates (unchanged) at 4.5% in December, and this rate is expected to remain broadly unchanged in 2006, partly because inflation is close to the government’s 2% target. Even so, base bank rates (down) are expected to fall from 4.75% in 2005 to 4.25%.

According to Experian, after four years of construction output growth above or in line with GDP, the industry is likely to have grown by about 2% less than the general economy in 2005.

Public sector spending

Although government spending on construction fell last year by a much greater extent than was expected, the CPA says it will be a driver of growth in 2006.

Michael Ankers, the CPA’s chief executive, says: “The deteriorating state of the government’s finances could mean that it is deliberately holding back on spending to bridge the growing gap between its income and planned expenditure.

“Our conclusion is that there have been special circumstances in 2005 – such as the hiatus that always occurs in letting contracts around the time of the general election and the fact that this also coincided with the commencement of the new spending review period. Together, these that have largely explained the fall, and they will not be repeated in 2006.”

Based on this theory, the CPA has predicted that government investment in non-housing projects (up) will rise 1.3% this year, compared with a 7.2% fall in 2005.

There were special circumstances in 2005 that largely explained the fall in government spending, and these will not be repeated in 2006

Michael Ankers, CPA chief executive

James Hastings, associate director at Experian, describes infrastructure (up) as “the sick man of the construction industry over the past three years”. However, this sector is expected to be a big drivers of the market’s modest growth in the coming year. The CPA predicts 5.5% growth in 2006, compared with a 10.3% fall last year. Experian’s figures are in line with that trend.

Public sector housing

The CPA has identified public sector housing (up) as one of the strongest areas of growth in 2006, up 8% compared with a 5% fall last year. Ankers says the blip last year, which came despite the government’s push for a growth in social housing, was caused by the disruption associated with the general election. Experian is also forecasting 6% growth for 2006 and 2007.

Private sector housing

As always, there are differing opinions on what the short term will hold. Housing research company Hometrack has predicted that house prices (up) will rise 1% in 2006, and at an average of 2.1% per year in the next three years.

The Council of Mortgage Lenders was more positive than this. It has revised its earlier prediction that house prices would remain flat to 2007, and now says they are likely to rise by 4% this year, and 2% annually in the two after that.

The RICS also believes prices will rise 4% this year and in 2007, based partly on its guess that interest rates will be cut by 0.25% in the first half of 2006.

However, Stuart Bernau, the chairman of the Council of Mortgage Lenders, warned: “We are not expecting a new surge in house prices or market activity. Given continuing affordability pressures, a flat outlook for interest rates and an economy that is likely to be stuck in neutral for much of the next two years, the outlook is for modest house price growth only.”

Property services company Savills has predicted that whereas average house prices in London and the South-east will rise 3% in 2006, they will fall between 4% and 5% in the rest of England and Wales.

In terms of output, the CPA predicts a 1% fall in private housing in 2006, whereas Experian predicts that output will remain flat.

Repair, maintenance and improvement

There was a difference in opinion between the CPA and Experian on what the short-term future held for the RMI sector. The CPA was more pessimistic, predicting that in 2006 RMI output (unchanged) would decline 0.5%, the same as in 2005.

Experian, on the other hand, has predicted that RMI is set to rise 1.8% in 2006.

We are not expecting a surge in house prices or market activity

Stuart Bernau, chairman, Council of Mortgage Lenders

Ankers describes the downturn experienced in the RMI sector in 2005 as “something of a blip”.

He adds: “There is still much to do to meet the target of bringing all social housing up to a decent standard by 2010.”

Commercial market

Office construction (up) showed a tentative recovery last year and the CPA is estimating that new orders will cause output in the sector to rise 8% in 2006, with further modest growth in 2007 and 2008.

A further boost to the commercial sector will be the introduction of Real Estate Investment Trusts, which were given the go-ahead provisionally for this month by chancellor Gordon Brown in his pre-Budget speech.

Jonathan Thompson, head of real estate at KPMG, says: “Although the legislation is by no means complete, it does set up a structure that will allow personal investors to easily invest in commercial property for the first time.”

The Olympics

While most of the construction industry is excited by the prospects and opportunities thrown up by the London 2012 Olympics, it will not feel the benefits immediately. Much of the work will begin after 2008, which puts it beyond the scope of the CPA’s survey.

The global picture

The possible disruption to oil supplies (down) and its effect on general inflation pose a continued risk to global growth.

Hastings says that the global picture is a threat: “The concern still remains that the USA will have to address its current account deficit, which has widened to more than 6% of GDP in recent years, before foreign investors decide to vote with their funds. The former could lead to a US recession and the latter to a sharp decline in the value of the dollar. Neither scenario would be helpful to the world economy.”

Overall outlook

To sum up, the industry looks set for tentative growth in output this year. Although this would compare favourably with the contraction of 2005, the industry is still heavily dependent on government investment.

According to the CPA, the best performing area will be non-housing work, which will rise from a –2% to achieve 2.1% growth in output, driven largely by the public sector.

But comments from the likes of health secretary Patricia Hewitt, who said early in December that every element of health spending was under review because of the cash crisis within the NHS, will not do much to inject the industry with new year cheer.