Tender price inflation forecast

Cooling demand could herald a plateau in tender price increases

2021’s surge in global demand lit the touchpaper of the spike in material costs. War in Ukraine and multiple lockdowns in China have since disrupted international supply chains, fanning the inflationary flames further.

If material cost volatility persists and uncertainty dogs the market, tender price inflation is likely to remain elevated. However, the probability of tender prices rising at the same pace, or faster, than they have done recently is low, and the likelihood of a reduction in tender price inflation is increasing.

Several factors support that view. First is the base effect. We’ve had two years of above average tender price inflation, driven by Brexit, COVID-19 and war in Ukraine. Even if we experienced similar disruption next year, the pace of tender price rises should fall in relative terms, readjusting to a certain extent.

Additionally, many forecasters are predicting lower levels of instability in 2023 – which if borne out would see inflation come down.

Next up, is time. Many inflationary pressures are outside the construction industry’s control and can endure for multiple periods. The impact of Russia’s war with Ukraine will depend on the extent to which the conflict, and the severity of sanctions and economic disruption, escalates. Its duration is unquantifiable.

Equally, this year has seen several factors that were one-off or finite. For example, the changes to red diesel fuel eligibility and National Insurance contributions should dissipate once they’ve been absorbed and fall out of the system.

Another consideration is an easing in demand-pull inflation. Increased costs and rising interest rates are combining to make construction less affordable and reduce confidence and capital expenditure, feeding into lower output growth. Both Experian and the Construction Products Association have revised down growth expectations in recent forecasting rounds.

Firms may then begin to shift pricing practices to adapt to changing market conditions. As construction activity softens, cashflows can become constrained in the absence of new work opportunities and pressure may then be applied to margins to secure the future pipeline of work.

Finally, there could be a cooling in cost-push inflation. Even though there will still be pressure stemming from the shortage of workers and dislocated supply chains, obstructive costs can filter into reduced demand and ultimately lower costs for construction materials and components.

Supply chains are also expected to mature, improving after years of significant disruption, building back stocks and increasing output by investing in new production facilities. Solving the tangle of port backlogs and shipping delays could also cool price growth and some indicators suggest the situation is improving.

Embattled contractors struggle to absorb input cost pain

The market is finely balanced, however, and there are downside risks that could see inflation become sticky and remain elevated even as demand pressures alleviate. The ability of contractors to absorb material cost increases will also play a part in tender price inflation allowances.

Contractors have experienced growing costs for materials and components over the past 12 months, with build costs spiking especially sharply in 2022.

The Building Cost Information Services (BCIS) General Construction Cost Index (GBCI) – as shown in Figure 3 - increased by 13.8 percent between May 2021 and May 2022. This is the highest month-on-year growth rate for 40 years and a notable leap from the 4.6 percent posted in May 2021.

Source: Building Cost Information Service

Input costs have risen across the board, but not all at a uniform pace. Cost escalation varies between materials and components. Some are above, and some below, the average.

Nonetheless, the underlying trend is upwards. While the pace of input cost escalation is likely to reduce as supply chains recalibrate from the initial impact of war in Ukraine, any potential reductions in costs may not translate into cost savings for those procuring construction work.

The relationship between cost and prices is a complex one. Much of it is behavioural and defined by the market at the point of tender. However, it is assumed that tender prices are inherently quick to rise and slow to fall, as contractors may opt to retain savings to balance their books against previously competitive bids and reinforce cashflows.

Source: Building Cost Information Service

Figure 4 shows the difference between the quarter-on-year change in the BCIS’ GBCI and Tender Price Index (TPI). Periods where input costs outstripped tender prices are shown in orange, whereas periods where prices rose faster than costs are shown in green.

Except for a brief period in Q1 2020, costs have increased faster than prices since Q4 2018. The difference ramped up towards the end of 2021 and has stayed high since, with a slight reduction in recent quarters.

In Q1 2022, costs outpaced prices by a punishingly high 4.1 percentage points. Contractors’ ability to absorb such significant input cost increases has steadily diminished.

As a result, any further increases in costs are likely to feed through into higher tender prices, variations and claims, given that contractors have already endured a harsh period of market volatility and surging input costs.

The secondary risk here is contractor insolvency and there are clear warning signals of coming contractor distress.

With input costs rising so quickly, contractors who have already submitted a bid or begun work will be forced to pay elevated materials prices that they struggle to pass on. In an industry with already tight margins, this pressure could rapidly push the weakest firms to the brink. This may also have a knock-on effect further down the supply chain with increasingly adversarial behaviour and heightened contractual tension arising.

To minimise risks, clients should increase engagement with their supply chain to understand potential problems and together develop pragmatic solutions to mitigate some of these effects.

What does this mean for our forecast?

Our central scenario estimates that real estate tender price inflation will increase by 8.7 percent in 2022 on average. This is a slight 0.2 percentage point uplift from our Spring 2022 forecast, where we anticipated an increase of 8.5 percent for 2022.

We have revised down our forecast for 2023, reducing our inflation expectations by 0.2 percentage points, moving from 4.0 to 3.8 percent. The forecast for 2024 has increased by 0.5 percentage points to 3.0 percent and the figure for 2025 has been maintained. A new forecast for 2026 has been added to our horizon at 4.5 percent, which is close to the long-term industry inflation growth rate.

Figure 5:

Tender price inflation: Annual percentage changes

Source: Turner & Townsend Survey

Our forecasts are representative for the UK as a whole and inflation may vary by project size, value, procurement route and region. Projects need to be assessed on an individual basis and may not always align to our central scenarios. For further assistance on cost assurance and inflation analysis in your area, please contact Turner & Townsend.

The construction industry is still in an upwards inflationary cycle. However, much of the uplift in 2022 has been felt already, with our inflation forecasts front loaded to the first half of the year. As the economy cools, supply chains stabilise and material cost escalation alleviates, the second half of 2022 is likely to see benign increases.

Source: Turner & Townsend Survey

Infrastructure tender prices have also changed. Our spring 2022 forecast set out a potential 6.0 percent increase and that has now been revised upwards to 8.0 percent, up by 2.0 percentage points. With visibility that recent cost increases are likely to remain high, combined with a high demand/opportunity, main contractors are pricing in inflation risk or declining to tender. The impact of this has been a higher rate in the tender prices than previously expected.

Source: Turner & Townsend Survey

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