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01 / executive summary

Tender price index

ºÚ¶´ÉçÇø prices throughout the country suffered a dramatic fall in the fourth quarter last year, dropping by 7.5% as contractors saw a gaping hole in workload ahead of them. As private sector building grinds to a halt, two years of falling prices are forecast.

ºÚ¶´ÉçÇø cost index

The ºÚ¶´ÉçÇø Cost Index recorded an increase of 7.4% over the year to the fourth quarter, its highest level for two-and-a-half years. Many materials prices rose through most of the year. The annual inflation rate is expected to rapidly decelerate in 2009.

Retail prices index

The rate of increase retracted sharply in the fourth quarter, down to 0.9% in December after three consecutive monthly falls. Housing costs and the VAT reduction were the main drivers behind this. The index is expected to be negative territory by the end of 2009.

02 / trends and forecast

The last market forecast, published in October, predicted falling building prices for the next two years. Analysis of tenders received in the last quarter of 2008 shows that prices dropped much more steeply than anticipated, falling by 7.5%, more than had been predicted for the whole of the year. The price reduction was led by the early trades of earthworks, concrete and brickwork together with reductions in on-costs such as profit and overheads and preliminaries.

Contractors and subcontractors suddenly saw a much leaner 2009 and took immediate action to try to secure workload. At the same time, the collapse in world commodity prices enabled sharp reductions in steel, metals and oil-related items to be written into tenders.

Not all projects have benefited from this price reduction. Those with strong exposure to imported components, such as European unitised curtain walling or a high proportion of mechanical and electrical services, have had to contend with rising prices brought about by the collapse of sterling.

Smaller contractors saw a drop in workload first. More than half of small and medium-sized contractors responding to the latest Federation of Master Builders’ state of trade survey made redundancies in the last three months of 2008, following four successive quarters of declining workload. The same percentage expect to have to make further redundancies in the first half of 2009, which could translate into 90,000 job losses.

Larger contractors and subcontractors were more confident for longer but gaping holes in workbooks began to appear in the second half of last year. Those contractors with large exposure to public sector work are better positioned, but those most active in the private commercial or residential sectors face a bleak outlook. This has encouraged contractors to work even harder to get onto frameworks and to pull out the stops in tendering for clients where there is the prospect of repeat business.

To aid the viability of schemes, contractors are now willing to pass on any savings they are able to secure from their supply chain. As steel and reinforcement prices have reduced, contractors have offered reductions to previously tendered figures. Six months ago, they were anxious to pass on in full any increased costs that came their way.

Although significant price falls have been observed in early trades, later operations such as office fit-outs have become very competitive. Mechanical and electrical services work is not experiencing quite the same level of competitiveness: the larger M&E firms appear to have firm order books for the next six-to-nine months but smaller firms are beginning to feel the pinch.

With future pipelines looking thin, more contractors are chasing work. Margins at the end of last year were significantly reduced and more cut-throat tenders can be expected as this year progresses. Profit and overheads levels, typically 5% but up to 8% six months ago, are already down to something like 2.5% to 3% with isolated examples of contractors going at 0%, in an attempt to secure turnover rather than profit. Preliminaries levels are falling with 12-13% now more typical than 14-15% six months ago.

As workload reduces during 2009, the market will progressively harden and there is likely to be a steady drop in prices with more aggressive commercial adjustments being built into tenders. The recent sharp drop in prices is not expected to be maintained as commodity price falls stabilise, profit and overheads levels have already been slashed, materials suppliers attempt to raise prices and the level of sterling makes imported goods more expensive. Nevertheless, prices overall are still likely to decline by 5-8% over the next year. As workload continues to constrict in 2010 another year of falling prices seems most probable and prices are forecast to fall by a further 4-6%.

Prices are unlikely to bottom out until some time in 2011. By then, the industry is likely to have suffered a large number of casualties and a degree of consolidation will have taken place. The available labour pool will have shrunk as well, as redundant workers find jobs in other industries and immigrant labour returns home. Any quick upsurge in construction, whenever it comes, could once again find itself a victim of rapid inflation.

03 / ten key issues for 2009

Global recession

Tight credit, consumer retrenchment and falling business investment will combine to deliver a synchronised global slowdown. The recession in many developed countries will be one of the deepest and longest in the post-war period. Growth in emerging markets will decelerate sharply.

Disinflation

Last year started with fears over runaway inflation and ended with concerns about deflation. This could result in a cycle of sinking demand, declining profit and credit and rising unemployment, leading to continuing downward pressure on prices.

The great unwind

Leveraging has powered growth in recent years. Banks and consumers are now cutting debt to repair balance sheets. De-leveraging has begun and will continue well into 2009.

Interest rates race towards zero

The US crossed the line first, cutting interest rates to 0-0.25%. The UK’s rate is down to 1.5%, its lowest level since 1648, with predictions it could go down to zero.

Fiscal stimulus

Governments around the world have initiated large-scale fiscal stimuli to prop up banks. More measures will be announced in 2009. In the US, the Obama administration has indicated a stimulus package of $500bn to $700bn. China is considering a big two-year programme worth about £437bn. By contrast, the stimulus plans announced in Europe, including in the UK, are thus far much smaller.

Commodity prices to remain low

The commodity price boom has ended, with prices collapsing during the second half of 2008, owing to a drop in demand. Oil prices could fall below the $30 mark in 2009. This will result in a drop in energy prices and falling investment, so the seeds for the next boom are already being set.

Global markets hit heavily

The lack of credit has hit global construction markets hard, with the US and western Europe worst affected. Governments have announced increased investment on infrastructure, but this is unlikely to offset the decline in private demand. Asia is also expected to see a slowdown. The brightest prospects for 2009 may be in the Middle East and Latin America. UK construction is expected to decline for at least two years. Recent forecasts point to a 12% reduction by the end of 2010 with no recovery until 2011.

Global balance shifts

Global economic balances are beginning to change. The decrease in materials and commodity prices signals a shift in the terms of trade, benefiting importing countries and balancing growth in favour of developed economies. In the UK, weak sterling should help export competitiveness and manufacturing output ought to benefit from a weaker currency by late 2009 or 2010.

Sterling to remain weak

Interest rates, competitiveness and confidence of investors all influence exchange rates. All three have pushed the pound down over the past year. The pound’s weakness reflects expectations of a more severe downturn in the UK than other countries and it is expected to remain weak in 2009.

Tentative recovery

The immediate outlook is far from positive. International trade will shrink in 2009 for the first time in more than 25 years, but nevertheless, it is hoped that fiscal intervention will contain the slowdown to a couple of years and produce a tentative recovery towards the end of 2009.

04 / output and orders

Official statistics showed output was still holding up well in the third quarter of 2008, the latest period for which figures are available. In fact, total new-build output in the first three quarters of last year was 1% higher than the same period of 2007. Total output was 2.5% higher than 2007. Housing was the only sector that fell, with third quarter output 19% down on 2007 levels.

The value of new orders, however, has been falling since the middle of 2007, with a significant drop since last May. The average monthly value of new orders between May and November slumped to £2.17bn (at 2000 constant prices), compared with £2.84bn in 2007 and £2.87bn in 2006, a fall of 25%. New private housing orders were more than 50% down, while private commercial work was 35% lower.

Public non-housing and infrastructure are the only two sectors set to grow in the next two years. The Construction Products Association is now forecasting three years of falling output such that total construction workload in 2011 will be 12% lower than in 2008. New work will begin to recover in 2011, but there will still be a fall of 14% over the next two years. Experian forecasts recovery in 2010 in both total work and new work. It foresees a drop of less than 7% in total workload this year before an infrastructure-led recovery in 2010. It predicts a total fall in new work of 10%.

05 / building costs

Tender prices may have fallen by the end of last year but underlying building costs registered a significant increase, with both labour and materials costs rising strongly. Labour costs were represented by the final part of a three-year wage agreement for building operatives, providing a 6% wage increase in basic rates at the end of June. Materials prices registered a record-breaking 9.5% rise over the year to November, maintaining an upward momentum until a small fall in November.

Labour costs

At the beginning of January, plumbers’ wage rates rose by 5%, in line with the rise in the retail prices index last September. This was more than the 4.5% rise promulgated in July 2007 in recognition of the higher than expected rise in living costs. Electricians’ rates rose by 4.5%, in line with the three-year agreement promulgated in September 2007 without a similar fail-safe clause.

ºÚ¶´ÉçÇø and civil engineering operatives will be expecting an increase in wage rates at the end of June but negotiations will be difficult in the current economic climate and they will be fortunate to secure an increase anywhere near that granted to electricians and plumbers.

Materials costs

Different sectors suffered markedly different increases in materials prices over the past year. Housing materials rose by just 4% over the year to November while non-housing building materials recorded a rise of 13.2%. Materials in the repair and maintenance sector increased in price by 6.4%. The muted increase in the housebuilding sector reflected the collapse in activity, where the number of housing starts in 2008 was almost exactly half that of 2007. This inevitably led to discounting of bricks, blocks and roof tiles in conjunction with a significant fall in timber prices.

The double-digit increase in non-housing materials prices was largely down to the rapid increase in steel prices which characterised the first half of 2008. Although steel prices started to collapse after the summer, it only started to bring down the price of the basket of goods in November.

January saw the issue of a large number of price rise notifications including aggregates (12%), concrete (12%), bricks (12-15%), plaster and plasterboard (9%).

With suppliers fighting for a reduced level of demand, it seems hard to imagine how price increases of this magnitude will be able to stick.

Steel

Steel prices took off again in 2008 as world demand accelerated and manufacturers faced huge increases in raw materials prices. But changing conditions in the middle of the year brought rising prices to a shuddering halt and prices quickly went into reverse. In the UK, Corus cancelled its planned price increase for September, sharply cut back production, and has just slashed 2,500 jobs.

Prices around the world started to fall in August and lost 40% in the last five months of 2008. This price fall was mirrored in Europe. However, the greatest falls have been in reinforcing bar and wire rod and structural steel sections have fallen, perhaps by 25%. In the UK, fabricated structural steel prices only started to decline in October and have probably fallen less than elsewhere in Europe.

Reinforcement prices collapsed in the last third of 2008, largely in response to the corresponding collapse in scrap prices, the main ingredient of reinforcement. Prices fell late last year to little over £400 per tonne, half the rate reached earlier in the year. European scrap prices fell 65% between June and November last year but bottomed out and rebounded slightly in December. Coupled with production cuts, reinforcement prices consequently lifted off the bottom. Some further recovery is expected in the first half of 2009.

Sterling

The collapse in sterling during 2008, and particularly in the last three months of the year, increased the price of a large number of building materials. In recent years, 25% of building materials and components have been imported, to a large extent from the Eurozone.

In the last three months of 2008, the pound fell 20% against the euro, automatically raising the price of goods such as curtain walling, ironmongery and air-conditioning units. Against the US dollar, the pound has fallen 30% since the end of July, similarly raising the price of imported mechanical services equipment and the like from across the Atlantic. Over the same period, the pound has depreciated by more than 40% against the Japanese yen, raising the price of lifts and other high-tech equipment from that part of the world to uncompetitive levels.

With the UK economy expected to fare worse than most over the coming months, the pound is not expected to rebound any time soon but any further deterioration is expected to be against the dollar rather than the euro.