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Plotting a course through turbulent times

Posted: Tuesday, November 1st, 2022

During the pandemic, the word ‘unprecedented’ was deployed regularly to describe the events and challenges before us. This autumn, it seems that ‘turbulence’ has been getting similar billing. Back on 23rd September, former Chancellor of the Exchequer Kwasi Kwarteng delivered his fiscal statement, the now infamous ‘mini budget’.

Of course, we now know that not only was it Kwasi Kwarteng’s first but remarkably, also his last fiscal statement. When the mini budget was announced, some economists called it the ‘biggest political roll of the dice in decades.’ Rather abruptly we were reminded, that the key markets are highly averse to big, unfunded surprises.

As we moved through October we saw the installation of a new Chancellor, U turns on virtually every signature mini budget proposal that wasn’t already going through Parliament, and a PM’s resignation. There still, of course, the prospect of further important changes in the weeks and months ahead, under new PM Rishi Sunak.

It’s worth noting that while ECA generally welcomed the business-related interventions in September’s mini budget, we were critical of the initial proposal to reverse the recent IR35 reforms. This was because many member businesses tell us that they really do not need see-sawing business policies, and even less so when they have invested in the policy change already.

Astonishingly, by mid-October we all learned that the IR35 reforms will stay after all. Elsewhere in what else remains of the mini budget – at least for now – ECA supports bringing onshore wind consents and planning ‘in line with other infrastructure to allow easier deployment in England’. Even so, recent government smoke signals about making it harder to deploy solar on hitherto PV-suitable farmland were not encouraging for those advocating clean energy.

Remarkably, PV installers found an unexpected ally in former Business Secretary Jacob Rees Mogg who apparently rejected telling farmers what they can and cannot do with their land. But continual political, policy and economic turbulence is only the backdrop to the day-to-day reality of conducting an engineering services business, of whatever size.

But as we know, our industry is also faced with persistent and underlying business and supply chain challenges. ECA members tell us they are very concerned about the long-term outlook, as businesses struggle with rising costs, and with recruiting skilled labour.

Over the past 12 months inflation in the engineering services marketplace was caused mainly by demand exceeding pre-pandemic levels. The sector worked hard to recover from the impact of the pandemic and to meet customer needs. However, global pressures are firmly behind UK and international inflation. While the pound moves around in periods of financial uncertainty, a sustained depreciation would further increase many material prices in a sector that has already experienced well over 20% price inflation.

Directly, the price of imported construction products (such as steel, copper, aluminium, and anything using semi-conductors) would undergo further price increases. In addition, attempts to switch to UK product sourcing, though laudable, may be ineffective if these products rely on overseas materials and components which may in turn be expensive or in short supply. On a global level fuel and energy is often priced in USD and a depreciating pound would add further to already sky-high operational energy prices that are affecting everyone.

Sharp rises in interest rates affect lending costs and mortgages when, due to inflation, real household income is falling. The market is said to expect interest rates to rise to around 6%. The result is rising finance costs and inflation, reducing demand in the housing market (both prices and transactions), and house building (the largest construction sector). Various published forecasts predict that national house prices may fall by 8% or so in 2023.

A fall in demand for housebuilding may be extremely hard and sharp. As household incomes struggle to cope with rising energy bills and stagnated real income due to double digit inflation, the domestic repair, maintenance and improvement sector (the 2nd largest market in construction) will struggle. Output has been falling since March and noting output in the sector in July 2022 was still 15.5 per cent higher than pre-pandemic, it may have a long way further to fall.

Commercial (offices, retail, leisure, the 4th largest construction sector) is reliant on large, upfront investment (often from international investors) for a long-term rate of return that is now under threat. Investors have become risk-averse to major investment in commercial towers when costs are also spiralling. So, we can reasonably expect that various projects will be paused (for repricing), pushed back, or cancelled. Theoretically, infrastructure should be the least affected as the key finance (central government/local authorities and regulated sector firms) is more stable.

However, sharp cost rises mean that, with constraints in November 2021’s 3-year Spending Review and 5-year spending plans for regulated sectors, we should expect expenditure but a fall in volume. In the medium-term, we might see projects pushed back into the next spending round, due to lack of finance. Meanwhile, local authorities, already financially constrained, may well see cutting new projects as a way to divert finances towards rising operational, repair and maintenance costs.

None of this will help to realise the current UK mantra of achieving growth. Nor does it bode well for the pipeline of work for the construction and maintenance sectors. Much of what happens next will be driven by global factors in addition to the government’s latest fiscal strategy, but the actions of government, will still be highly significant for our sector.

ECA continues its considerable representational efforts with government and our key industry stakeholders on behalf of our sector. In addition, we provide all Members with access to free, experienced and highly relevant operational information and advice. If you’d like to know more about what we can do to help your business to plot a course through the challenges ahead, contact C&C@eca.co.uk.

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