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Economic Insight

UK Business Confidence Monitor: Construction

Q4 2022: The Business Confidence Index is the weakest across all sectors

The latest Business Confidence Monitor (BCM) shows business confidence falling further across the UK as difficult economic conditions combine with political turmoil. The latter has seriously unsettled financial markets, and although some stability has been restored, recent events are likely to result in higher interest rates, taxes and government borrowing, and lower government spending, than previously expected. This has adversely affected business sentiment.

The survey results are based on telephone interviews among ICAEW Chartered Accountants that took place between 25 July and 14 October 2022.

  • The Business Confidence Index continues to fall from its near-record high in mid-2021. It is well into negative territory and shows a lower reading than that of any other sector.
  • Domestic sales growth is also softening, and companies have the second weakest growth expectations for the year ahead, behind Property. The squeeze on the economy due to inflation and the recent hikes in interest rates largely explain this outlook.
  • Continuing supply-side issues are also clearly damaging business sentiment. Annual input price inflation in Q4 2022 is outpacing all other sectors.
  • Labour costs are rising at their fastest rate in 15 years. This reflects widespread concerns over the availability of non-management skills.
  • Despite selling prices increasing more sharply than in other sectors, profit growth is slowing, and a further moderation is expected over the next year.
  • Weaker sales prospects help to explain why customer demand is also becoming a more widespread concern. Transport problems remain elevated, while the ability to expand into new areas has become a much more prominent problem.
  • Investment rates are expected to weaken markedly. Capital investment growth is set to slow, while Construction is the only sector that plans no rise in Research & Development budgets over the coming 12 months.

Business confidence in the Construction sector

After reaching a near-record high in Q2 2021, the Business Confidence Index in Construction has declined in each subsequent quarter. It is now firmly in negative territory, just as it was during the peak of the pandemic. With an index reading of -30.0, the Construction sector is the most downbeat in the UK.

The weakness in business confidence partly reflects the supply-side problems faced by companies in the sector. With a strong reliance on imported components and raw materials, the sector has been particularly exposed to recent surges in global commodity prices, and the ongoing disruptions to supply chains. Reflecting this, input costs are rising more sharply in Construction than in any other sector. At the same time, businesses are also contending with widespread challenges relating to the availability of non-management skills. And these difficulties are being further compounded by an increasingly uncertain outlook for both consumers and businesses, with activity in the sector likely to weaken as inflation squeezes household and company budgets, and borrowing costs rise due to interest rate hikes.

Domestic sales growth

During the pandemic construction activity contracted sharply as demand for both residential and commercial building work collapsed, and restrictions were initially placed on working. The easing of restrictions across the UK in 2021 and the subsequent upturn in economic activity provided the base for a strong rebound in sales growth, which continued throughout the early parts of 2022. However, after rising at a record annual rate in Q3 2022, domestic sales growth now appears to be easing, with a 5.5% increase achieved in the year to Q4 2022, compared with 8.8% in Q3 2022. And a weaker outturn of 3.6% is expected over the coming 12 months. With the exception of Property, this is the slowest outlook across all sectors.

Input and selling prices, and profits growth

Significant supply-side difficulties are also likely to be weighing on sentiment within the sector. Continued disruption to the functioning of supply-chain networks has led to rising prices of key raw materials such as steel, concrete and timber. Cost pressures have also been intensified by the ongoing Ukraine-Russia war, something that is particularly challenging for energy-intensive sub-sectors in Construction. Brexit is also probably a factor at play here, with the introduction of new custom controls and regulatory requirements likely to be pushing up costs for businesses.

Against that backdrop, input price inflation has reached its fastest rate since the survey began, with input costs rising by 7.6%, year-on-year. This is faster than in any other sector. A further increase of 5.8% is expected over the next 12 months, outpacing other sectors apart from Manufacturing & Engineering. This is still over twice the historical average for Construction and indicates that businesses do not expect current cost pressures to ease significantly over the year ahead.

In response, businesses in Construction have increased selling prices charged to customers at the fastest rate (5.1%) since the survey began in 2004. This outpaces all other sectors. And Construction companies are planning a 3.8% increase over the year ahead, which would be greater than the UK average.

The overall result of these cost-price dynamics is a 3.6% rise in profits over the past 12 months. This is the second weakest increase across all sectors, ahead of only Manufacturing & Engineering. Looking ahead, profit growth is expected to slow further to just 1.8% in the next year, with only the Property sector forecasting a smaller increase.

Employment and skills

Employment growth is closely tracking the national trend, with employment levels 2.9% higher over the past 12 months and a further 2.0% increase expected for the year ahead. However, the rate of workforce expansion trails the stronger growth in sales, which may reflect ongoing difficulties regarding labour recruitment. Indeed, the most widespread growing challenge faced by businesses in the Construction sector is the availability of non-management skills. With 57% of businesses reporting the issue, this is the highest proportion since the start of the survey and is higher than in any other sector. This may be partly a result of Brexit-related restrictions to the inflow of workers from EU nations, on whom businesses within the Construction sector are historically very reliant. The movement of workers out of the labour force before and during the pandemic may also help to explain the skill shortage within the industry. Staff turnover is also at a record high in the sector, with 41% of businesses reporting it as a growing challenge.

In response to these issues, average total salaries are up by 4.1%, the joint fastest rate within the sector since mid-2007. A further increase of the same magnitude is expected over the next 12 months, which would be the joint sharpest rise across sectors, along with Transport & Storage.

Business challenges

Business challenges are, of course, not just confined to the labour market. Customer demand is an especially prominent issue within the sector, with 39% of businesses citing it as a rising source of difficulty, exceeded only by Retail & Wholesale. Transport problems remain a major challenge, with 35% of businesses citing this as a source of growing difficulty. This reflects the sector’s high dependency on the movement of raw materials on a tight schedule, which is likely to be vulnerable to any continued shortfall in HGV drivers. It is also striking that expanding into new areas has surged as an issue in Q4 2022 and now stands at 20%, making it more widespread than in any other sector.

Investment growth

Given the range of problems that businesses are dealing with, it is encouraging that both capital investment and Research & Development (R&D) budgets have been rising. The former is up by 2.1% in the year to Q4 2022, and the latter by 2.4%. However, plans for the next 12 months are much more subdued. Indeed, companies plan to increase capital investment by just 1.0%, an even slower outlook than the modest UK average of 1.4%. Weaker still are R&D budgets, with businesses intending to keep spending at the same level as they are now. Construction is the only sector that does not expect growth in R&D over the next 12 months. This is a concerning development given that the sector has a continuing need to invest in new construction methods, not just to raise productivity, but also to shift towards more carbon-neutral methods of construction, and to create a more climate-friendly and energy-efficient building stock.