Simon French, Chief Economist
Simon French is the Chief Economist at Panmure Gordon. Prior to joining Panmure he worked for the UK Government, latterly at the Cabinet Office as Chief of Staff to the UK Government COO.
He had a central role in implementing the Coalition Government’s spending reforms between 2010 and 2014 as well as working on the Governments Welfare and Pensions reforms between 2002 and 2008.
He holds an Undergraduate and Postgraduate degree in Economics from Durham University.
- Activity indicators and stock prices have declined in recent weeks;
- New orders data indicates a headwind from recent political events;
- Underlying demand remains well-supported, particularly outside of London;
- Structural drivers of demand favour a resilient UK construction sector.
Recent data have pointed to a slowdown within the UK construction sector. Investors have taken note and there has been a marked underperformance of construction-related equities over recent sessions.
Even hitherto strong Homebuilders have seem the combination of slowing selling prices and the increased likelihood of a UK interest rate increase put the dampeners on prices: Figure 1.
In this post we assess the latest economic data in detail, and consider whether recent moves reflect a sectoral turning point or the volatility of an uncertain UK economic and political outlook.
Construction is the sector of the UK economy most sensitive to consumer confidence. Since 1990 the correlation between confidence and changes in construction output has been +0.54. Lower positive correlations have been observed for the production, services and agriculture sectors: Figure 2. This quantitative assessment is consistent with recent qualitative evidence from UK construction surveys. These indicate a downturn in sentiment arising, in part, from the combination of the 2014 Scottish Referendum, 2015 General Election, 2016 Brexit Referendum and 2017 General Election.
Coupled with these political events are recent trends in UK construction data. These have damaged investor sentiment - already cautious against the backdrop of the recent slowdown in UK economic growth that has moved from the fastest in the G7 to the slowest within the last 12 months. These data points include:
- The UK Construction Purchasing Managers Index (PMI) has slowed markedly since May (51.9 in August). This activity measure has now declined for three successive months to stand at its lowest level since September 2016. Orders for new work have also declined to post their slowest rate of increase since May 2013 : Figure 3;
- The quarterly output data from the ONS which reported a sharp slowdown in orders during Q2, with the YoY change turning negative for the first time since Q3 2012: Figure 4;
- A regional split in order volumes has emerged with London and Scotland underperforming. By contrast construction orders have picked up in northern England: Figure 5. Anxiety over the London market acting as a leading indicator for the wider sector has further fuelled concerns.
However, this muted outlook is not universal across the sector. Indeed there are parts of the construction market that point to a more promising second half of the year. For example the Builders Merchants Index is showing robust activity by UK merchants, up 6.6% YoY in July - Figure 6 - led by home improvement activity.
Furthermore inflation amongst materials and labour costs is showing increasing signs of having peaked: Figure 7, which will moderate the pressure on margins over the coming months. Housing starts (and completions) remain near their post-crisis highs: Figure 8, with recent signals from the UK government that the social housing sector will receive additional financial support during the upcoming legislative session.
We expect domestic, residential construction to remain well supported by accommodative financing conditions. Mortgage approvals, while well below their pre-crisis levels, are gradually ticking higher: Figure 9. We are seeing increasing evidence that Pensions Freedoms continue to be a tailwind for one-off spending on housing repair and maintenance: Table 1 with flexible payments hitting a new high in Q2 of £1.86bn.
|Table 1: Flexible payments from pensions|
We remain attracted to the structural growth story within UK construction. High household formation rates, latent capacity through recent underinvestment in housing and civil infrastructure points to a catch-up over the coming years as the government addresses public concerns.
In contrast with much of the UK economy the competitive challenge posed to UK firms in increasingly contestable goods and services markets is more limited within the construction sector. Furthermore outside the European Union we expect the UK government to take a more UK-first approach to the award of civil engineering and construction contracts.
The challenges of Brexit-related uncertainty on the UK’s labour supply, public policy and regulatory framework cannot be dismissed - but the UK’s electorate’s recent shift towards favouring a more expansionary fiscal policy should help to offset these risks during the UK’s departure from the EU.