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The UK economy is growing at its fastest rate for at least four years, according to government statistics for GDP, with growth in the second quarter of 2004 at 0.9% higher than the first quarter. This annualised rate of 3.7% is ahead of Gordon Brown鈥檚 Budget predictions of annual growth of 3-3.5% for both 2004 and 2005.

The Office for National Statistics says construction has increased in line with the rest of the economy in the second quarter. The DTI鈥檚 construction output statistics for the second quarter will not be available until the beginning of September, but figures for the first quarter continued to scale new heights. The seasonally adjusted figure represented a volume at 9% higher than a year earlier.

The volume of construction orders in 2003 was, in real terms, nearly 5% lower than 2002, as orders for both private commercial work and infrastructure declined by 12%. But in the first five months of 2004 there has already been a recovery. Infrastructure orders remained considerably lower but the private commercial sector experienced significant gains.

All the recent surveys into construction activity have been buoyant. The Federation of Master Builders鈥� second quarter 2004 survey identified a five-year unbroken sequence of quarter-on-quarter increases in stated workload. The most recent increase extended to all regions of the country except London. Similarly, The Chartered Institute of Purchasing & Supply鈥檚 latest Report on Construction has noted continuous growth of total industry activity since February 1999.

The RICS in its Quarter 2 2004 UK Construction Market Survey identified workloads rising at a record pace for the survey, with commercial activity rising sharply and clients and developers increasing their confidence and optimism over the wider economy.

As well as buoyant market conditions, the industry has been faced with underlying cost inflation greater than for a number of years. DTI statistics show that the price of construction materials rose by 3% between January and May this year, with the price of precast concrete products up 5%, sawn timber up 5%, fabricated structural steel up 5%, sand and gravel up almost 9% since December, copper pipes up 17% and reinforcement bars up 46%.

As a result, construction price inflation in many regions has been more than double that of general inflation over the past year. However, London (and to a lesser extent parts of the South-east) has bucked the national trend and tender prices over the past year have increased at a lower rate than the Retail Prices Index: over the past nine months prices have been static.

The reason behind this lies with the decline in construction workload in London, contrary to the national trend. New work output in the capital has been in gentle decline since the middle of 2002, down from 拢2180m in the third quarter 2002 to 拢1867m in the first quarter 2004. The most significant drop has been in the private commercial sector, though there has been a slight pick-up in activity since autumn of last year.

Contractors鈥� new orders in London in the first quarter were boosted by some large orders in the private commercial and private housing sectors but only after a very lean second half of 2003. As a result, the office fit-out market is particularly keen and prices are probably lower than a year ago. M&E services prices in and around London have been static for 18 months, though prices elsewhere, including the Midlands and Wales, are often rising ahead of other work sectors. And unlike most other regions, there are currently few shortages of traditional trades in the capital and site rates have been stable for some time.

Outlook

Both the short- and medium-term outlooks for the construction industry are healthy. New-build across the UK has grown 6% over the last two years in spite of a significant drop in private commercial work last year. Instead the industry has benefited from a large influx of public sector spending on education and health. In cash terms construction spending on schools, colleges and universities more than doubled between 2000 and 2003 with 拢3.7bn of public sector money spent last year on education building. Another 拢1.4bn was spent through private funding.

The recent Comprehensive Spending Review has reaffirmed the government鈥檚 commitment to investment in health, education, transport and housing between 2005 and 2008, with real average annual increased spending of 7.2% for health and 4.1-4.6% for the other sectors.

A significant proportion of this additional spending will be invested in the built environment. The plan to refurbish or rebuild 鈥渢o 21st-century standards鈥� every one of England鈥檚 secondary schools over the next 10 to 15 years was announced in 2003 under the banner of 好色先生TV Schools for the Future. A recent announcement is for 2500 鈥淐hildren鈥檚 Centers鈥� to be built by 2008 and up to 200 more academies by 2010. The DfES鈥� capital budget will rise from 拢3801m in 2004/05 to 拢5545m in 2007/08.

The National Health Service has already embarked upon what it calls 鈥渢he biggest NHS hospital building programme in history鈥� and construction spending in the public health sector increased by 54% between 2001 and 2003, rising to 拢1667m last year, as well as 拢652m spent on privately funded health construction work. However the slowness of PFI procurement has been well documented and faster processes will have to be introduced to speed up delivery as promised. The NHS鈥� capital budget will rise from 拢3.38bn in 2004/05 to 拢6.13bn in 2007/08.

The NHS LIFT scheme, launched in 2002, is beginning to produce improvements in primary care and community-based facilities with new surgeries, clinics and health centres. Using private sector partners in joint ventures with local health bodies, three waves of schemes have already established LIFT companies, and have preferred bidders or shortlists for schemes worth more than 拢1150m. Applications for a fourth wave are currently being sought.

Gordon Brown has pledged an extra 拢1.3bn for housing over the next three years, including 拢430m allocated to the Housing Corporation. This is intended to provide an extra 10000 social rented houses a year by 2007/8, though this is only half the number recommended in the Barker Review. In addition, funds for housing market renewal pathfinders in the north of England will treble from 拢150m this year to 拢450m in 2007/8.

The Comprehensive Spending Review earmarked an annual 4.5% year-on-year increase in transport spending between 2004 and 2008. However, the recent review of the 10-year transport plan has been treated with dismay in some quarters. It is feared that funds for road construction will be axed to pay for higher spending on railways. The previous commitment to build all the schemes on the Highways Agency鈥檚 targeted programme of improvements has been dropped and all proposed tram schemes have been cut as uneconomic. Crossrail has at last been given the green light but with funding still to be decided, a start on site still seems some way off.

Forecast

Both Construction Forecasting & Research, part of the Experian group, and the Construction Products Association have issued revised forecasts of construction output for 2004 to 2006 since the Comprehensive Spending Review was published. Contractors鈥� orders have fared better than expected and the private sector, encouraged by an improved world economic outlook and UK prospects in particular, seems to be recovering more quickly than anticipated.

Total construction output has been forecast to increase between 3 and 3.5% in 2004, according to CFR and the CPA respectively 鈥� more optimistic than earlier predictions of 1.5-3.2%. And expectations for private commercial work, although still expected to decline, are more hopeful at a fall of 4.4-5%, compared with the previously anticipated 4.7-6% drop in output.

Construction prospects throughout the country over the next two years seem positive in every sector. Public sector commitments have been further strengthened by the spending review. In the private sector, even the industrial building market shows signs of improvement as world demand picks up, exports grow and consumer spending shows no sign of easing.

A report by the CBI and GVA Grimley has now found that companies are more optimistic than at any time since 1996 but growth in demand for commercial property has mainly been driven by retailers. The value of new orders for shop construction work in the first five months of 2004 were some 60% higher than in 2003.

The construction market in London hinges heavily on office development, the collapse of which over the past year or so has dragged down output. But optimism is certainly returning to the market. Figures recently released by CB Richard Ellis suggest that office take-up across central London has risen to its highest level for three years and there has even been an increase in West End rents. A report by the Centre for Economics and Business Research predicts that an extra 35,000 jobs will be created by London鈥檚 financial institutions between now and 2008, with half of them coming over the next 18 months. London developers have taken note.

Most commentators believe that construction output this year will grow almost as much as during 2002 and 2003 and will continue to grow next year, albeit at a slightly reduced rate. Even in London, activity has probably bottomed out and will begin to rise. But pressure on resources will continue to plague the industry. All the key construction procuring government departments have expressed fears over the industry鈥檚 ability to deliver big increases in spending programmes. Earlier in the summer, the Department of Health was reported to have decided to limit the number of major hospitals that it was trying to take to the market at the same time. The ability to be able to deliver Crossrail in a timely and economic manner has been questioned and the Office for Government Commerce is undertaking a review of the industry鈥檚 capacity to deliver the enhanced public spending programme, particularly at a time when the private sector begins to recover.

As well as market pressures exerted by supply and demand, contractors are also faced with substantial underlying cost increases. Construction wage awards already agreed for the year ahead range from 4.5% for heating and ventilating operatives in October 2004 to 9.5% for building operatives in June 2005. The use of imported labour has helped to peg the growth in site wages over the past two years as construction demand is at record levels.

Materials costs are likely to continue to rise at their higher than usual level. Although oil prices seem to have stabilised, at $40 a barrel, prices are almost double the level of 18 months ago and are generally predicted to stay at that level as world demand continues to increase. Higher production costs are still feeding through into end prices. And the hike in steel prices does not yet seem to have reached its peak. Basic steel prices have risen by 25-30% so far this year but are expected to have risen by 50% or 拢200 per tonne by the end of the year. Subcontractors are reluctant to offer fixed prices and clients are pre-ordering their steel requirements as lead times begin to lengthen, particularly for hollow and non-standard sections.

The new EU landfill directive came into force on 16 July ending the co-disposal of hazardous and non-hazardous waste in the same landfill site, driving the cost of disposal of hazardous waste up to between 拢50 and 拢70 a tonne.

As a result of increased workload and underlying cost pressures, building tender prices around the country are likely to increase at a slightly faster rate over the next 12 months than over the past year. In London, prices are predicted to rise 3-4% over the next year but in some regions rises may nudge 5%. Over the year to the second quarter of 2006, as the London construction market rebounds, prices may well rise by 4-5% whereas price pressure in the rest of the country will ameliorate.

Around the UK

The East Midlands has seen the largest rise in construction activity over the last year with a surge in private housebuilding and in repair and maintenance. Many contractors claim full order books and a resurgence of cover prices is noted.

Wales, too, has benefited from a drive in private housebuilding but has also seen a near doubling of public sector spending on new building works. However the 44% rise in construction spending over the last two years has resulted in labour resourcing problems, both on site and among management and consultant work forces. All trades are in short supply but particularly brick and block layers.

The buoyancy of Wales has been almost matched by the much larger construction region of the North-west of England. Here the private commercial sector has bucked the trend of the South-east and continues to benefit from substantial new investment. Manchester鈥檚 regeneration has been under way since much of the city centre was destroyed in 1996 but now Liverpool, European Capital of Culture for 2008, has begun its own regeneration.

Construction growth in Scotland in recent years has been steady rather than spectacular but the market currently is buoyant, particularly in and around Glasgow. Contractors鈥� order books are quite full and skills shortages are common. Edinburgh will get less busy with major projects completing this year, notably the Scottish Parliament and the Royal Bank of Scotland.