Government spending to grow ahead of expected May election, but house and energy prices cause concern

Growth in construction output is to fall from 3.2% in 2004 to 0.8% in 2005, according to a report published today by the Construction Products Association.

The CPA is predicting falls in growth across the board, but the sectors hardest hit will be housing, down from 14.2% to 7.5%, and repair and maintenance, which will suffer an absolute fall of 3.4%.

The association’s findings are in line with developments in housebuilding in 2004. Although most firms posted strong results, some warned that market conditions were becoming “more challenging”. Housebuilders also suffered from rapid inflation in materials costs caused by a surge in energy prices.

The market will continue to be underpinned by government expenditure, particularly in the education and healthcare sectors, but to a lesser extent than in 2004. Growth in spending on the crucial public non-housing category is forecast to fall from 18.6% to 9.6%.

The CPA predicts that this will be partly explained by a fall in expenditure after the next general election.

Building spoke to the CPA and a group of industry experts to get an overview of their predictions for construction in 2005.

UK growth

In the UK, economic growth → is expected to moderate to about 2.5% over the next three years, as increased government spending offsets slower consumer spending.

GDP growth ↓ is forecast to slow from 3.25% this year to 3% next and bank base rates are expected to plateau at 5% over the coming 18 months as consumer price inflation picks up.

According to the report by the CPA, the strengthening of the Euro ↑ might improve the UK’s export opportunities in Europe, but eurozone trading conditions are likely to remain sluggish.

In the contracting sector, the closing months of 2004 brought downbeat trading statements from Gleeson, Mowlem and Alfred McAlpine, and this had a negative impact on the sector. As a result, share prices ↓ dropped across the board.

Construction output ↑ will continue to grow, but at a rate of only 0.8% compared with last year’s 3.2%. And although contractors are generally upbeat about their prospects, which are largely driven by education, health and affordable housing schemes, the CPA says that government spending : is expected to moderate.

The chancellor’s decision to relax council expenditure controls during 2005/06 will divert spending away from roads, schools and houses

CPA report

Private sector activity ↓ is forecast to deteriorate next year, before recovering slightly in 2006.

Housing market

There remains a diverse opinion on what will happen to the housing market in 2005. Some predict a 30% crash in house prices, whereas others, such as the Council of Mortgage Lenders, expect a 4% rise.

Further interest rate rises are not forecast ahead of the general election, which is expected in May, and unemployment levels in the UK remain the lowest in Europe and are still falling. So the fundamentals remain positive, and the housebuilders say they are cheered by the government’s commitment to provide an extra 70,000 homes a year by 2007/08.

The CPA says: “While a soft landing is anticipated for the general housing market with only modest falls in house prices, there is a significant risk of a sharper correction in house prices initiating a more pronounced contraction in consumer confidence and housing related construction.”

The CPA expects the number of home completions J in 2005 to rise 2.2%, to 183,000. Independent housing research group Hometrack says house prices → will remain flat. “I expect prices to continue to fall in the first few months of 2005 by up to 3%,” says John Wrigglesworth, Hometrack’s housing economist. “But we should see a stronger performance in the last six months, meaning that house prices should finish the year in the same shape they started it.”

Material price rises

Commercial activity → is expected to remain flat, as hopes earlier in the year that the office market was picking up in London and the South-east – which underpin the market in the rest of the UK – were not realised.

The continued increase in energy prices J and the resultant hike in building materials costs ↑ has far-reaching implications, including consolidation among the materials companies in 2004. In November, Mexican company Cemex completed a £2.3bn takeover of RMC, the UK concrete manufacturer, and builders’ merchant Travis Perkins has just agreed a £950m deal to buy DIY retail chain Wickes.

Deals such as these mean that in future, the industry’s suppliers will have “a lot more clout”, according to Alastair Stewart, an analyst at Dresdner Wasserstein Kleinwort .

“A big piece of consolidation in the sector will certainly limit the chances of prices falling,” Stewart said. “It could lead to a shift of power from the housebuilders to the materials companies.”

I expect house prices to continue to fall in the first few months of 2005 by up to 3%

John Wrigglesworth, Hometrack

Last year the UK was hit by a 50% hike in the cost of structural steel ↑ Clients pay about £1350 a tonne, and a rise of £50 a tonne is expected this month. QS Davis Langdon predicts that in 2005 steel prices will moderate, but that this will not stop rises in materials prices.

Cement costs ↑ are likely to increase by up to 15% in the first quarter of this year alone. Cement production is an energy-intensive process, and hikes in the cost of coal and electricity – said by manufacturers to be 20% and 50% respectively – will be absorbed by the contractor.

Glass prices ↑ are also expected to rise. Glass production is also energy-intensive and glass manufacturers are introducing a surcharge based on the price of oil.

These predictions were made before recent consolidation in the sector, which will create fewer but more dominant suppliers, and so price rises may be greater than the CPA foresaw.

Global growth

The world’s economic outlook ↑ is broadly better than it was 12 months ago, thanks to the beginnings of a recovery in the US and Japanese markets. The burgeoning market in China, however, and the resulting rise in commodity prices, has curbed the pace of economic recovery in the USA and Europe.

China’s demand for energy will have a big long-term impact on energy prices. According to the International Energy Agency, demand is likely to increase almost 60% by 2030. Two-thirds of the extra demand is expected to come from developing countries, mainly China and India.

Overall outlook

In the short-term, the future looks positive because the government is unlikely to curb public spending near a general election. Education, health and housing are seen as key vote-winners and government will want to keep to its building targets.

Beyond the election, the industry should be wary about relying on government spending to fuel long-term growth.