Higher VAT and NI contributions plus the spending cuts spell a double dip recession for the sector

It’s shaping up to be another tough 12 months for the construction sector, as VAT increases and higher employer National Insurance contributions combine with government spending cuts to spell a year of contraction.

Higher materials costs will erode profit margins because the fierce competition for work - predicted to continue all year - means contractors will not be able to pass increases on to customers looking to procure work at the lowest prices.

Government spending cuts will also begin to bite harder during 2011, as work already under way nears completion.

Given the depth of the cuts announced in last October’s Comprehensive Spending Review, this work will not be replaced on anything like the same scale.

After growing about 4.5% during 2010, according to the Construction Products Association (CPA), the sector is forecast to see a 2% fall in output during 2011, followed by a further 0.7% drop in 2012.

The CPA has also estimated that the value of work in the sector will fall from £99.1bn in 2010 to £96.4bn in 2012. This is equivalent to £4.7bn less work than if sector output was maintained at 2010 levels.

Although the CPA predicts that the construction sector will suffer a double-dip recession, the wider economy looks likely to avoid the same fate.

A survey of 78 leading economists by the Financial Times this week suggested that despite the severity of government spending cuts and the VAT increase, the UK economy overall should avoid a double dip.

But it faces a potential threat later in the year, when interest rates may need to be increased from the current 0.5% in order to combat the effects of inflation, which is already running at more than 3%.

At some point in the future the Bank of England will also have to reverse its quantitative easing (QE) programme, which has pumped £200bn into the economy.

Reversing QE could take some time and have a negative effect on bank lending. New European rules, which require banks to hold more capital to offset the effect of bad debts, could be another constraining factor for lending throughout 2011.

Despite the negatives surrounding the industry, there will be some bright spots.

Private housing starts are forecast by the CPA to grow 5% in both 2011 and 2012, while the commercial sector recovery should take hold as a number of high-profile projects start on site.

Rail construction will also enjoy a strong few years as output grows from £2.3bn in 2010, to £4.5bn in 2011.