Construction Industry Forecasts Winter 2017/18 Edition

Transcription

1 Construction Industry Forecasts Winter 2017/18 Edition

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3 Contents Overview 4 Scenario A - Lower Scenario 10 Scenario B Upper Scenario 12 Economy 16 Private Housing 20 Private Housing RM&I 26 Public Housing 28 Public Housing RM&I 30 Public Non-housing 32 Public Non-housing R&M 36 Commercial 38 Private Non-housing R&M 46 Industrial 47 Infrastructure 50 Infrastructure R&M Construction Products Association. All rights reserved. This document is licensed for the exclusive use of Members of the CPA and purchasers of its economic forecasts ( 210, including 20% VAT). Please do not publicly distribute this document. Additions to the distribution list can be made by contacting the CPA at DISCLAIMER All construction figures (starts, completions, orders and output) refer to Great Britain. All output figures are in 2015 constant prices using the historic figures from the Office for National Statistics (ONS). All new orders figures are in 2005 constant prices using the historic figures from the Office for National Statistics (ONS). The information in this booklet has been prepared by Construction Products Association and represents the views of Construction Products Association without liability on the part of the Construction Products Association and its officers. 3

4 Overview Construction output is forecast to remain broadly flat in 2018, rising by only 0.2%, before growth of 1.7% in The overall construction output figures mask varying fortunes across the different construction sectors and growth over the two years is forecast to be heavily dependent on housing outside the capital and infrastructure. Without this growth in these sectors, construction output would fall by almost 2.0% in 2018 and remain flat in Outside of the private housing and infrastructure sectors, slower UK economic growth and uncertainty around slower growth prospects is expected to weigh on construction output in private sectors. This, combined with the persistent uncertainty created by the slow progress of the UK government s negotiations on the terms of leaving the EU, has acted as a considerable hindrance to major new investment in private sector construction, especially for new high-end residential and commercial offices projects within London that are particularly reliant on foreign investment. Construction activity to remain broadly flat in 2018 Key Points Immediately following the EU referendum the CPA s forecasts made clear assumptions regarding Construction output to remain broadly flat in 2018 (0.2%) and rise 1.7% in 2019 Private housing starts to rise 2.0% in 2018 and 2019 Offices construction to decline 15.0% in 2018 and 10.0% in 2019 Retail construction to fall 5.0% in 2018 but rise 2.0% in 2019 Infrastructure work to rise by 6.3% in 2018 and 11.1% in 2019 the post-brexit period, after March 2019, on the basis that these assumptions would be revised once there was clarity on the government s post- Brexit objectives and the likely outcomes of the negotiations with the EU. However, 18 months on from the referendum, there is still little clarity regarding the likely situation for people/skills flows and products trade between the UK and the EU. The UK and EU have at least agreed a deal on the first phase of the negotiations, allowing discussions to move on to topics such as a transitional deal in early However, there is little sign that clarity will be provided in the near-term and political uncertainty regarding the type of Brexit desired by the UK government remains. As a consequence, the uncertainty that has hindered new international investment in markets such as high-end residential and commercial offices over the last 18 months is likely to continue. Clearly, the most important development in construction since the last CPA forecast is the liquidation of Carillion, the UK s second largest contractor, on 15 January The nature of major contracting, with major firms subcontracting out the majority of work, means that there is a long supply chain and between 25,000 and 30,000 firms may be affected. The last significant size contractor to undergo liquidation was ROK in 2010, which had an annual turnover of 715 million. The UK construction element of Carillion s 5.2 billion business accounted for 1.5 billion per year. At the time of writing, in late January, construction work on solely Carillion sites had stopped although joint ventures should be largely unaffected as the partner contractor will take over Carillion staff. According to Barbour ABI, there are currently 72 key projects spread primarily across infrastructure, including around 350 million of Network Rail work, defence construction, education including PFI and health including PFI. The impact on construction activity will be dependent upon the length of hiatus on Carillion sites and the effect on firms in the construction supply chain of non-payment of retentions and construction work prior to the liquidator taking over on Monday 15 January, 4

5 especially given Carillion s 126-day payment terms. All of these issues are uncertain at this point and the impacts will also be influenced by the extent of government action to help address Carillion-related issues and the speed at which the liquidator PwC can transfer and/or re-tender existing Carillion contracts. UK GDP growth in 2017 Q4 was 0.5%, broadly in line with quarterly GDP figures in 2017 but significantly slower than the 0.7% seen one year ago. Overall, GDP growth in 2017 was only 1.8% higher than in GDP growth is expected to slow further in 2018 due to the impacts of falling real wages on household spending and of Brexit-related uncertainty on business investment, partly offset by the boost to export-related manufacturing from previous depreciations in the value of Sterling. In terms of the number of jobs, the UK labour market remains buoyant and UK employment at the end of 2017 was amongst the highest rates seen since comparable records began in Despite this, the persistence of falling real wages raises questions about the quality of jobs being created and also suggests that employers are uncertain about prospects for demand. The rise in commodity and component prices over the past year suggests that high inflation is likely to persist in 2018 and that the fall in real wages is likely to endure, which would be expected to continue to adversely affect consumer spending. However, the real wage falls are less of an issue for those with substantial housing and pension wealth, particularly in older age demographics. Output in the private housing sector continued to grow in 2017 and is expected to rise further, by 3.0% in 2018 and 2.0% in 2019 as growth in private house building outside London is partially offset by falls in house building in the capital. This is in spite of a generally subdued housing market in Property transactions have been distorted by changes to stamp duty in 2014 and in 2016 that adversely affected sales at the top end in the main. Property transactions in 2017 were slightly lower than transactions in the last two years and, in line with mortgage approvals, indicate a broadly flat to slightly negative general housing market. UK house price inflation in 2017 was 3.0% compared with 2016 according to Nationwide, which indicates that the supply of properties onto the market has slowed in line with demand. Whilst there remains significant house price inflation, house builders will be keen to increase supply, especially given that the government s Help to Buy has skewed incentives for home buyers towards new build. Help to Buy accounts for over one-third of private house building starts, and almost 40% for major house builders. However, a key recent trend has been a decline in new starts for the majors. Starts in the three months to October were 5.2% lower than a year earlier whilst starts for the top house builders over the same period were 1.2% higher, which has been slowing over the past year. SME starts in the three months to October were 3.7% higher than a year earlier. At this stage it is too early to indicate whether the majors are 5

6 aware there are issues in the market that smaller house builders may become aware of later in Anecdotally, major house builders still appear positive with respect to increasing supply but, as ever in private house building, Springtime will be key, particularly this year as government will also be publishing its interim review into the gap between completions and permissions at the Spring Statement in March. The key part of the housing market and house building market that appears to have been adversely affected over the past year is the market for prime London properties. House prices in central London have fallen 15.0% since their peak in 2014 according to Savills, partly due to stamp duty changes that have affected demand but also due to an oversupply of new properties that has built up in recent years as house builders chased high margins on exclusive properties. Furthermore, uncertainty regarding rates of return on high-end properties from international investors due to short-term economic uncertainty and longer-term Brexit uncertainty has also affected demand for prime residential in the capital. NHBC starts in Inner London between 2017 Q1 and Q3 were 27.0% lower than one year earlier but in Outer London starts in the first three quarters of 2017 were 6.5% higher than a year ago. Private housing repair, maintenance and improvement (RM&I) is the third largest construction sector, worth 19.9 billion. The repair and maintenance part of the sector tends to be relatively flat when adjustments are made for seasonal variation so significant changes tend to be based around the refurbishment part of the sector. In the main, property transactions have a positive relationship to refurbishment activity on existing properties with a 6-9 month lag. Given slightly negative property transactions over the past year, this would suggest falling output in private housing rm&i, particularly given that a higher proportion of transactions than normally would be the case involve new build, due to Help to Buy. However, above a certain price point, that differs by area, activity by an older demographic with housing and pension wealth is negatively related to property transactions as they tend to prefer to improve rather than move. This activity has been sufficient to provide growth for the sector offsetting falls for other homeowners suffering from real wage falls. Furthermore, it is expected that this demographic will provide growth during the first half of As a result, private housing rm&i output is expected to remain flat in 2018 before falling by 2.0% in Infrastructure output continues to be the key driver of growth despite concerns expressed in previous forecasts regarding delivery of capital investment on the ground and issues raised previously regarding delays on major projects. In the last three months there have been anecdotal indications that delivery on the fiveyear spending plans is starting to improve and growth in activity is being seen on the ground for roads and rail. In terms of major projects, HS2 contracts for main work have been signed during the last few months. Seven of the largest construction contracts since September have been HS2 contracts and we would anticipate that the activity from this is seen on the ground from the end of this year but primarily in Overall, output in the sector is expected to rise by 6.3% in 2018 and 11.1% in Within this, roads construction is expected to remain flat in 2018 and rise by 3.0% in Within water & sewerage, forecasts remain unchanged from three and six months ago as activity under the five-year AMP6 spending plan continues and growth is driven by the 4.2 billion Thames Tideway project. Water & sewerage output is expected to rise 12.0% in 2018 and remain flat in The forecast for output in the rail sector also remains unchanged as work under the CP5 five-year spending plan will be boosted by main works on HS2, from the end of 2018 but are expected to primarily impact on output from Energy infrastructure activity is expected to grow by 7.0% in 2018 due to offshore wind farm activity and growth rates are expected to rise to 14.0% in 2019 as main works at Hinkley Point C finally begin. However, as with previous forecasts, further delays to the project cannot ruled out that would take main works out of the forecast period. As indicated in previous CPA publications, commercial offices new orders have fallen since the EU Referendum in June 2016 and, following the month lag between orders and output in commercial projects, output has fallen since Summer last year. Offices output still remains high due to flexible offices space demand in London 6

7 and Technology, Media and Telecommunications (TMT) demand in Manchester. However, the EU referendum marked a clear break between certainty of demand in the sector and fortunes looking forward. Prior to the referendum, there were already concerns regarding the commercial market peaking and high prices being quoted for potential commercial investors, especially in London, yet demand remained strong. However, post-referendum, international investors and developers adopted a more risk-averse behaviour towards new projects and new orders fell sharply in the second half of 2016, by 19.9% compared with a year earlier and orders in the first three quarters of 2017, were 22.3% lower than during the first three quarters of As a result, output in the offices sub-sector is expected to fall by 5.0% in 2017, 15.0% in 2018 and a further 10.0% in Activity within the retail subsector is expected to be boosted by low value supermarket chains, particularly Lidl, who placed planning applications for 68 new stores in 2017 that are expected to be built in the next two years. Lidl also announced in January that it will build a 1.0 million sq. ft. regional distribution centre in Hertfordshire. In addition, the 1.4 billion Croydon Partnership has finally been given the green light by the Mayor of London and main work should start in Main works at the 1.4 billion Brent Cross extension are expected to get on the ground in at the end of this year and boost retail sub-sector output next year. However, it is unlikely that this will be enough to offset reductions in activity this year within the retail sector due to the long-term trend towards online shopping, falls in real wages impacting on consumer spending patterns in addition to legislation to prevent on local authority spending on private commercial property as investments. A decline of 5.0% is expected in retail output during 2018 before output returns to growth with a rise of 2.0% in 2019, driven primarily by work from Lidl and the two 1.4 billion London projects. Overall, commercial sector output is expected to fall by 5.0% in 2018 and 1.4% in 2019 as the fall in orders feeds through onto the ground. Public sector construction is expected to suffer from a lack of finance available and a lack of projects in the pipeline. This is in spite of the need to deal with urgent works on 299 towers above 18 metres that were deemed unsafe following the tragic events at the Grenfell tower in June Public housing rm&i activity is expected to fall by 2.0% in 2018 and only rise by 5.0% in Within education and health the pipeline for new projects appears to have dried up. Sharp falls in both sectors have been avoided as cost overruns and delays mean that work on projects initially scheduled to finish this year have now extended out to 2019 at the earliest. Education including PFI and Health including PFI are expected to fall by 3.6% and 5.6% respectively in Furthermore, output is expected to remain flat in education including PFI output in 2019 whilst health including PFI output is expected to rise by Construction Output 160, , % 1.5% 8.9% 4.4% 3.8% 3.0% 0.2% 1.7% million Constant Prices 120, ,000 80,000 60,000 40, % 20, e 2018f 2019p Source: ONS, Construction Products Association 7

8 only 0.6% in Two of the four major projects on which Carillion suffered 1.0 billion of write downs were the two PFI hospitals in Liverpool and Birmingham. As a result, it is likely that further delays will occur and risks are towards the downside. DISCLAIMER 1: The Office for National Statistics (ONS) made major revisions to the construction output data in October The result of this was to add an extra million per month from March 2015 into the infrastructure sector. As a result, there is now a structural break in the ONS infrastructure sector and sub-sector output data and 2015 ONS infrastructure data cannot be compared with data from previous years. However, the ONS has assigned work on the 4.2 billion Thames Tideway Tunnel shortly after the new orders in As a consequence, the CPA is forecasting actual activity growth in the infrastructure sector and sub-sectors rather than forecasting distortions in the ONS data. DISCLAIMER 3: The ONS has substantially revised upward all historic data going back to 2016 Q2. Construction output between January and July 2017 was initially 1.3% higher than a year earlier. However, the ONS has revised this up to 5.1% higher than a year earlier with the significant step up in construction output at the end of 2016 whilst simultaneously construction employment remained broadly flat. DISCLAIMER 2: The ONS determines subsector output by utilising the new orders data and an average length of time between orders and output. However, this means that major one-off projects may be assigned to output by the ONS earlier than it actually occurs. An illustration of this is in the water and sewerage sub-sector. General activity in the sector occurs under frameworks and often takes relatively little time to feed through from new orders to output as a part of general works under five-year plan ONS Construction Output (September & October 2017 Data Releases) October Release September Release 8Construction Output (2013=100) Source: ONS

9 Construction Industry Forecasts - Winter 2017/18 million 2015 constant prices % annual change Actual Actual Estimate Forecast Projection Housing Private Public Total 26,277 29,768 31,256 32,194 32, % 13.3% 5.0% 3.0% 2.0% 5,049 4,814 5,295 5,454 5, % -4.7% 10.0% 3.0% 3.0% 31,326 34,582 36,552 37,648 38, % 10.4% 5.7% 3.0% 2.1% Other New Work Public Non-Housing Infrastructure Industrial Commercial Total other new work Total new work 10,374 10,750 10,600 10,362 10, % 3.6% -1.4% -2.2% 0.7% 18,403 17,812 18,534 19,698 21, % -3.2% 4.1% 6.3% 11.1% 4,733 4,409 4,250 4,250 4, % -6.8% -3.6% 0.0% -1.1% 26,219 28,139 28,971 27,509 27, % 7.3% 3.0% -5.0% -1.4% 59,729 61,110 62,355 61,819 63, % 2.3% 2.0% -0.9% 3.0% 91,055 95,692 98,907 99, , % 5.1% 3.4% 0.6% 2.7% Repair and Maintenance Private Housing RM&I Public Housing RM&I Private Other R&M Public Other R&M Infrastructure R&M Total R&M TOTAL ALL WORK 18,577 19,895 21,288 21,288 20, % 7.1% 7.0% 0.0% -2.0% 8,141 7,680 7,296 7,150 7, % -5.7% -5.0% -2.0% 5.0% 11,488 11,991 12,111 12,111 12, % 4.4% 1.0% 0.0% 0.0% 5,047 4,975 4,926 4,827 4, % -1.4% -1.0% -2.0% 0.0% 8,811 8,267 8,432 8,432 8, % -6.2% 2.0% 0.0% 0.0% 52,064 52,808 54,052 53,808 53, % 1.4% 2.4% -0.5% -0.1% 143, , , , , % 3.8% 3.0% 0.2% 1.7% Source: ONS, Construction Products Association 9

10 Scenario A - Lower Scenario Scenario A Assumptions GDP growth in 2018 slows from the 0.3%-0.5% quarterly growth rates seen during 2017 Unemployment begins to rise marginally due to the further slowdown in economic activity Real wages continue to fall throughout 2018 as employers and employees respond to uncertain economic conditions in spite of sustained inflation Two interest rate rises during 2018 Property transactions fall further due to the slowing demand in London spreading outside the capital Government does not increase capital investment further for infrastructure despite announcements Main works on HS2 subject to delays Scenario A Key Effects Construction activity falls in 2018 due to a slowdown in the UK economy that, in turn, leads to existing contracts being put on hold and new contract awards falling. Output falls by 3.2% in 2018 and 2.8% in 2019 Private housing output falls by 2.0% in 2018 and by 5.0% as a potential slowdown in the housing market The further slowdown in property transactions and real wages falls could also have an adverse impact on private housing rm&i work, which until now has largely been sustained by an older wealthier demographic for whom real wage falls have not been as great an issue so far. In this case output declines by 3.0% in both 2018 and 2019 Further declines in business and consumer confidence would negatively impact, in turn, on business investment and retail spending respectively. This could lead to greater falls in demand for new high-profile commercial offices and retail space. Commercial output in this scenario declines 8.5% in 2018 and 6.6% in 2019 Contractor issues on high-profile major projects such as HS2 could means that infrastructure output does not grow by as much as anticipated in the main forecast. In this case, infrastructure output grows by only 3.2% in 2018 and 4.0% in

11 Construction Industry Forecasts - Winter 2017/18 - Lower Scenario million 2015 constant prices % annual change Actual Actual Estimate Forecast Projection Housing Private Public Total 26,277 29,768 30,959 30,340 28, % 13.3% 4.0% -2.0% -5.0% 5,049 4,814 5,247 5,195 5, % -4.7% 9.0% -1.0% 0.0% 31,326 34,582 36,206 35,534 34, % 10.4% 4.7% -1.9% -4.3% Other New Work Public Non-Housing Infrastructure Industrial Commercial Total other new work Total new work 10,374 10,750 10,341 9,794 9, % 3.6% -3.8% -5.3% -2.6% 18,403 17,812 18,393 18,990 19, % -3.2% 3.3% 3.2% 4.0% 4,733 4,409 4,177 4,060 3, % -6.8% -5.3% -2.8% -5.0% 26,219 28,139 28,330 25,914 24, % 7.3% 0.7% -8.5% -6.6% 59,729 61,110 61,242 58,758 57, % 2.3% 0.2% -4.1% -2.4% 91,055 95,692 97,448 94,293 91, % 5.1% 1.8% -3.2% -3.1% Repair and Maintenance Private Housing RM&I Public Housing RM&I Private Other R&M Public Other R&M Infrastructure R&M Total R&M TOTAL ALL WORK 18,577 19,895 20,890 20,263 19, % 7.1% 5.0% -3.0% -3.0% 8,141 7,680 7,219 6,858 6, % -5.7% -6.0% -5.0% 2.0% 11,488 11,991 11,991 11,751 11, % 4.4% 0.0% -2.0% -2.0% 5,047 4,975 4,876 4,681 4, % -1.4% -2.0% -4.0% -4.0% 8,811 8,267 8,349 8,099 7, % -6.2% 1.0% -3.0% -3.0% 52,064 52,808 53,325 51,652 50, % 1.4% 1.0% -3.1% -2.2% 143, , , , , % 3.8% 1.5% -3.2% -2.8% Source: ONS, Construction Products Association 11

12 Scenario B Upper Scenario Scenario B Assumptions UK economic activity accelerates to quarterly growth rates above 0.5% per quarter Employment remains at highest level on record and employee pressure raises nominal wages to ensure real wage growth UK exports of goods and services continue to rise significantly following the depreciations in Sterling over the past 18 months Consumer spending growth in 2018 despite sustained inflation due to a return to real wage growth Government improves infrastructure delivery in line with announcements under the government s National Infrastructure and Construction Pipeline Scenario B Key Effects Construction output rises by 4.3% in 2018 and by 5.2% in 2019, primarily due to growth in private sector construction, in turn, due to UK economic growth Private housing output rises by 4.0% in both 2018 and 2019 as Help to Buy continues to sustain the market and the housing market in London starts to recover following recent falls in demand for prime residential A recovery in property transactions growth could boost general private housing rm&i activity outside of the growth currently sustained by the older, wealthier demographic Following falls in commercial activity in the second half of 2017 and first half of 2018, sustained growth in consumer spending could boost high street commercial retail as well as online spending whilst an ongoing shift towards flexible offices space could also boost offices demand. In this case Commercial output would rise 2.3% in 2018 and 2.8% in 2019 Infrastructure output increases by 16.0% in 2018 and by 19.6% in 2019 as accelerated construction activity at HS2 is boosted by improved delivery from Highways England and Network Rail 12

13 Construction Industry Forecasts - Winter 2017/18 - Upper Scenario million 2015 constant prices % annual change Actual Actual Estimate Forecast Projection Housing Private Public Total 26,277 29,768 31,554 32,816 34, % 13.3% 6.0% 4.0% 4.0% 5,049 4,814 5,344 5,557 5, % -4.7% 11.0% 4.0% 5.0% 31,326 34,582 36,898 38,374 39, % 10.4% 6.7% 4.0% 4.1% Other New Work Public Non-Housing Infrastructure Industrial Commercial Total other new work Total new work 10,374 10,750 10,855 11,274 11, % 3.6% 1.0% 3.9% 3.3% 18,403 17,812 18,735 21,728 25, % -3.2% 5.2% 16.0% 19.6% 4,733 4,409 4,295 4,393 4, % -6.8% -2.6% 2.3% 1.0% 26,219 28,139 29,419 30,086 30, % 7.3% 4.5% 2.3% 2.8% 59,729 61,110 63,305 67,482 73, % 2.3% 3.6% 6.6% 8.2% 91,055 95, , , , % 5.1% 4.7% 5.6% 6.7% Repair and Maintenance Private Housing RM&I Public Housing RM&I Private Other R&M Public Other R&M Infrastructure R&M Total R&M TOTAL ALL WORK 18,577 19,895 21,487 21,916 22, % 7.1% 8.0% 2.0% 2.0% 8,141 7,680 7,373 7,520 7, % -5.7% -4.0% 2.0% 5.0% 11,488 11,991 12,111 12,353 12, % 4.4% 1.0% 2.0% 2.0% 5,047 4,975 5,025 5,025 5, % -1.4% 1.0% 0.0% 1.0% 8,811 8,267 8,432 8,601 8, % -6.2% 2.0% 2.0% 2.0% 52,064 52,808 54,427 55,415 56, % 1.4% 3.1% 1.8% 2.3% 143, , , , , % 3.8% 4.1% 4.3% 5.2% Source: ONS, Construction Products Association 13

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16 Economy The preliminary estimate of GDP growth for 2017 Q4 was 0.5%, following on from 0.4% in Q3 and overall for 2017 growth was 1.8% compared with 1.9% in In 2018, GDP growth is expected to slow to only 1.2% but with a high degree of variance around the forecast regarding the extent to which uncertainty around the UK s Brexit negotiations will impact upon business investment and the extent to which falling real wages will impact upon consumer confidence and spending. This uncertainty is highlighted in HM Treasury s summary of the latest main City and Non-City economic forecasters. Of forecasts made in the last three months of the year, the most optimistic anticipates UK GDP growth of 2.6% in 2018 and the most pessimistic forecasts growth of only 0.5%. The average of the forecasters is for UK GDP growth of 1.4% in 2018, slightly higher than the CPA s forecast as the majority of forecasters are expecting CPI inflation to slow significantly during throughout The latest information from Markit/CIPS on the key industry sectors continues to highlight mixed fortunes across the UK economy. GDP growth set to to 1.2% in 2018 The Markit/CIPS PMI for manufacturing was 56.3 in December, down from November s 51-month high of The latest reading was above the nochange mark of 50, indicating that manufacturing 16

17 activity expanded for a seventeenth consecutive month, with output, new orders and employment all reporting robust growth. Output growth picked up in the intermediate and investment goods sectors, whilst slowing for consumer goods. Meanwhile, input costs eased to a four-month low in December but remained elevated, whilst selling prices rose for a twentieth successive month. The Markit/CIPS PMI for construction was 52.2 in December, down from 53.1 in November but above the no-change mark of 50 indicating that construction activity expanded, primarily driven by a strong increase in residential building work. However, commercial building reported a modest decline in December, whilst civil engineering activity remained subdued. The latest data showed that new orders rose at its fastest pace since May 2017, reflecting resilient demand for new construction projects. Furthermore, the survey revealed that cost pressures persisted in December, albeit lower than February s peak, with survey respondents reporting higher prices for materials and particularly imported products. Looking at the next 12 months, optimism fell to its weakest since mid- 2013, with survey respondents attributing this to uncertainty over the UK economic outlook. The Markit/CIPS PMI for services was 54.2 in December, up from 53.8 in November and marking the second-fastest upturn in the services sector since April Despite this, the latest survey showed that incoming new work increased at its slowest pace since August 2016, whilst the rate of job creation fell to a nine-month low with some firms noting difficulty in replacing departing staff, as well as efforts to reduce operating costs. Meanwhile, input price inflation reached a threemonth high in December, with service providers citing higher fuel prices, utility bills, food costs and salary payments. In November, the Bank of England raised interest rates from 0.25% to 0.5%, still historically low and it is likely that the Bank will look to review demand and supply side conditions early in the new year before any further changes. However, the Bank did signal that rates are likely to rise further in the next couple of years and as a consequence the CPA has had to pencil in a further rate rise in 2018 despite slowing GDP growth. However, clearly signalling further rates rises is unlikely to be helpful to consumer confidence in a period of real wage falls and uncertainty. In terms of CPI inflation, macroeconomic forecasters at the end of 2016 underestimated the impact of depreciations in Sterling on inflation a year on and the early indications are that macroeconomic forecasters have underestimated inflation once again. Although previous depreciations in Sterling will fall out of the Economic Indicators Actual Actual Estimate Forecast Projection GDP 2.3% 1.9% 1.7% 1.2% 1.5% Fixed Investment 2.8% 1.8% 3.0% 1.0% 2.0% Household Consumption 2.7% 3.1% 1.5% 1.7% 1.0% Real Household Disposable Income 5.3% 0.2% -0.5% 0.7% 1.2% Government Consumption 0.6% 0.8% 0.4% 0.4% 0.3% CPI Inflation 0.0% 0.7% 2.7% 2.5% 2.0% RPI Inflation 1.0% 1.8% 3.6% 3.0% 2.7% Bank Base Rates - June 0.50% 0.50% 0.25% 0.50% 0.75% Bank Base Rates - December 0.50% 0.25% 0.50% 0.75% 0.75% Source: ONS, Construction Products Association 17

18 The UK labour market continues to thrive in terms of employment and unemployment. Between September and November 2017, the employment rate was 75.3%. Over the same period, the unemployment rate was 4.3%, down from 4.8% a year earlier and the joint lowest rate since Despite this, real wages continued to fall and remain lower than ten years ago, prior to the financial crisis. Between August to October 2016 and August to October 2017, in real terms, regular pay for employees in Great Britain fell by 0.5% and total pay for employees in Great Britain fell by 0.2%. annual CPI figures during 2018, this is likely to be at least partially offset by double-digit increases in commodity and component prices during the last year. Of forecasts made in the last three months of the year, the most optimistic anticipates CPI inflation growth of only 1.8% in the year to 2018 Q4 and the most pessimistic forecasts growth of 3.0%. The average of the forecasters is for CPI inflation to rise by 2.3% in the year to 2018 Q4 and the Office for Budget Responsibility forecasts CPI inflation of 2.0% over the same period. The CPA forecasts the inflation rate to average 2.5% over the year as a whole. The depreciations in Sterling since the EU Referendum, combined with rising global trade, have boosted the fortunes of exporters, particularly manufacturers. Total manufacturing rose by 3.9% in the three months to November compared with a year ago. The total UK trade deficit on goods and services fell by 2.1 billion in the three months to November 2017 due to a 1.2 billion narrowing of the trade in goods deficit, in turn, due to a rise in UK goods exports. In addition, UK trade benefitted from a 0.9 billion widening of the trade in services surplus due to increases in services exports. Almost one year on from the letter triggering Article 50 giving the UK two years to leave the EU, there is little clarity regarding the relationship between the UK and EU after March However, the UK and EU have agreed a deal on the first phase of Brexit talks, which allows talks early this year on the transition deal and future UK-EU relationship. The Prime Minister has stated that she envisages an implementation period of around two years and the indications are at this stage that it is likely to be a softer Brexit than previously suggested but the negotiations process continues to raise speculation that means this is still uncertain. Downside Risks: Economic activity slows sharply during 2018 Unemployment rises due to the fall in economic activity Real wages fall due to rising inflation combined with constrained nominal wage growth due to rising unemployment Lending to businesses is weak despite Bank measures to increase liquidity and lending If UK economic activity slows more than expected, this will impact upon consumer and business confidence. This may lead to falls in consumer spending and business investment and, in turn, would slow economic activity further leading to a rise in unemployment. The Bank of England s interest rate rise may exacerbate the slowdown. Any further falls in Sterling would be likely to impact upon import prices, and therefore UK inflation at a time when wage growth is likely to be constrained by the rise in unemployment. 18

19 Upside Risks: UK economic activity rises significantly in the first half of 2018 Unemployment continues to be subdued The depreciation in Sterling leads to a persistent increase in UK net trade and global inflows of finance into the UK Real wages continue to grow despite the anticipated rise in inflation Measures by the Bank of England to boost lending and liquidity help to ensure that businesses and consumers have finance available Unemployment 1.43 Million 1.7 Million Consumer spending growth in 2018 despite rising inflation If UK economic activity grows at rates of 0.5% per quarter or above, the unemployment rate would be anticipated to fall even further. The UK economy would be likely to benefit from exports and global inflows of investment in prime residential and commercial properties, especially in Central London. UK economic growth would be expected to ensure real wage growth despite the rise in inflation. In addition, growth in the wider UK economy and real wage growth would be September Source: ONS, Construction Products Association expected to lead to rises in consumer expenditure. Further increases in capital investment could boost construction, manufacturing and professional services activity. However, one counterpoint to this remains that substantial growth in construction may place even greater pressure on skills shortages that have been reported for many occupations in the industry including planners, site managers, bricklayers and carpenters. 4.5% 4.0% Interest Rates and Inflation Bank of England Base Rate CPI RPI 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% Source: Bank of England, ONS 19

20 Private Housing Private housing output reached a record high in 2017 Q3 and the 10.0 billion extension to the government s Help to Buy equity loan is expected to maintain demand for new build housing and support activity throughout the forecast period. Private sector house building is closely linked to the performance of the housing market, driven by mortgage lending, property transactions and house prices. Bank of England data show that mortgage approvals picked up in 2017 Q3 after declining in annual terms in every month between June 2016 and June However, renewed weakness in October and November means that approvals for the year to date were 0.9% lower than the same period of UK Finance has highlighted Private Housing Starts and Completions Great Britain Actual Actual Estimate Forecast Projection Starts Completions Output ( m) RM&I Output ( m) 140, , , , , % 4.8% 7.0% 2.0% 2.0% 129, , , , , % 2.9% 12.0% 3.0% 1.0% 26,277 29,768 31,256 32,194 32, % 13.3% 5.0% 3.0% 2.0% 18,577 19,895 21,288 21,288 20, % 7.1% 7.0% 0.0% -2.0% Source: MHCLG, ONS, Construction Products Association 20

21 6.00 Affordability House Price/Earnings Ratio First Time Buyers Affordability Ratio Mortgage Payment as a % of Income Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q3 Source: Nationwide a lower level of buy-to-let lending since the 3.0% stamp duty surcharge on additional properties was introduced in April 2016 and first-time buyers now account for half of house purchases, compared to one-third historically. Similarly, property transactions for the January to November period of 2017 were 0.4% below the levels recorded during the same period of UK Finance forecasts lending and purchase activity to remain around these levels throughout 2018 and Despite weaker volumes of mortgage lending and house purchases, particularly from the buyto-let segment of the market, UK house prices have continued to increase. The Royal Institution of Chartered Surveyors (RICS) and Savills, along with other estate agencies, have highlighted that a reduction in the supply of existing properties for sale is contributing to upward pressure on house prices and whilst this inflation continues, there would be expected to be an associated increase in house building. According to the ONS/Land Registry, national house prices rose 5.1% yearon-year in November, led by the West Midlands (7.2%), the East Midlands (6.4%), the North West and the South West (6.2% each). Regional house price dynamics will also need to be monitored in An increase in the supply of higher-end residential units in inner London has led to house price falls in prime central London, with the Help to Buy equity loans have been used to purchase 30.0% of new build completions in England Nationwide house price index for Q4 suggesting that falling prices have begun to spread to the outer London boroughs. The index registered the first fall in London house prices in eight years in December and average prices recorded by the Land Registry fell each month between August and November. Questions also remain over the sustainability of high volumes of house building and strong house price growth in Manchester and Salford. Reflecting general macroeconomic uncertainty, forecasts for house price inflation in 2018 Q4 in the HM Treasury s comparison of independent economic forecasts in January averaged 2.0%, with a range between -3.0% and +4.2% for the year to 2018 Q4. The Help to Buy equity loan, which was introduced in April 2013, has been a significant government policy for supporting new build housing activity. Between its introduction in April 2013 and September 2017, the equity loan was used on 21

22 140 Lending to Individuals Total Mortgage Approvals for House Purchase (number) Remortgaging (value) Total Mortgage Approvals (value) 60% % Secured Lending - Total Approvals (000s) % 30% 20% 10% 0% -10% Lending 3 month change on a year earlier 0 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17-20% Source: Bank of England 144,826 transactions in England, and whilst this accounts for only 3.1% of property transactions over the period, it represents 30.0% of new build completions. Furthermore, in the most recent four-quarter period, this proportion rose to 35.3%. For three of the top ten volume house builders, equity loan purchases are reported to be used in over half of their sales. The counterpart schemes in Scotland and Wales have accounted for a similar proportion of transactions and building activity. In England and Wales, the equity loan scheme will be in operation until March 2021, but in Scotland, the maximum eligible purchase value under the scheme will be tapered. This was reduced from 230,000 to 200,000 in April 2017 and will move lower to 175,000 from April Despite the strong uptake in equity loans nationwide, it is difficult to ascertain the substitution impact of how many of these purchases would still have occurred had the policy not been in place. Nevertheless, with the post-2021 period now entering house builders strategic plans, the industry is pressing for an extension to the scheme beyond this date. In the November Budget, the government announced 15.3 billion of additional support for house building. However, 8.0 billion of this is in the form of financial guarantees, with no further detail. It did include an extra 2.7 billion in funding through the Housing Infrastructure Fund. In July, local authorities were able to bid for a share of the initial 2.3 billion allocation, which formed part of the 23 billion National Productivity Investment Fund announced in Autumn Statement The funding is formed of two parts: the marginal viability fund and the forward fund. The former is capped at 10.0 million per bid, and aims to top up funding for projects facing an unforeseen shortfall in finance for site infrastructure. The latter is for larger, strategic infrastructure projects, with up to 250 million in early finance available for each bid, with an aim of de-risking projects to attract other investment. The Budget also pledged funding tranches for a Land Assembly Fund, remediation for small sites and the Home Building Fund for SMEs. The funding profile for these measures will not peak until 2019/20 and beyond, however. These policies, along with long-running planning reforms and industry consultations outlined in the government s Housing White Paper and the Mayor of London s draft housing strategy have, therefore, not been factored into the forecast. The permanent stamp duty holiday for first-time buyers announced in the Autumn Budget is expected to result in a minor easing of affordability, mainly in London and the South East where the full 5,000 saving can be achieved, but as highlighted in the Office for Budget Responsibility s assessment, it is unlikely 22

23 to provide a significant increase in purchases that would not otherwise have occurred. According to Nationwide, the house price to earnings ratio for first-time buyers in London was 9.8 in 2017 Q4 and 5.2 on a national level. The government is keen to develop the Build to Rent sector, which covers new build developments for private rent that aim to generate a long-term return on investment. According to the British Property Federation, there are 54,905 units of this tenure with planning permission, concentrated mainly in London, Manchester and Birmingham. This has potential to provide some uplift to house building activity, but it is difficult to apportion activity between the private contractors and the housing associations active in this sector of the housing market. In England, statistics from the Department for Communities and Local Government (DCLG and now renamed the Ministry of Housing, Communities and Local Government) showed that private housing starts in 2017 Q3 fell 6.0% from Q2 but were 0.9% higher year-on-year. For the year to date, starts increased 12.2%. In Q3, private housing output rose 1.8% in quarterly terms and reached a record high level of 7.9 billion. This is likely to reflect an increase in change of use development, particularly offices to residential. In 2016/17, DCLG s net housing supply statistics show that change of use accounted for 37,190 additional units, or 17.1% of total net supply of 217,350. This has increased from 9.4% ten years earlier. New orders for private housing in Q3 were 0.5% higher than a year earlier, following an 8.0% fall in Q2. The downside risk to demand stems from the deterioration in real wages and incomes. Inflation rose to a five-year high of 3.1% in November and was 3.0% in December (see Economy), outpacing increases in wages and salaries and, therefore, reducing households willingness to make large purchases. The Bank of England raised interest rates by 0.25 percentage points at its November meeting. With the bank rate now at 0.5%, it remains at a historically low level and by itself is unlikely to have a material impact on demand. However, combined with lower real incomes, hawkish statements from policymakers may set expectations for higher future interest rates and worsened affordability. The CPA expects interest rates to rise to 0.75% in the second half of 2018 (see Economy). As a consequence, private housing construction growth is expected to moderate from the rates registered in recent years. After an estimated 7.0% increase in 2017, private housing starts are forecast to increase 2.0% per year in 2018 and Downside Risks: Sustained falls in real wages deter Help to Buy purchases Property Completions by Type % Private housing completions by type (England) Houses Flats / / / / / / / / / / / / / / / / /17 Source: MHCLG 23

24 Mortgage lending and property transactions fall in 2018 London house price weakness extends to UK regions The Bank of England raises interest rates more than once during 2018 Real wages have declined since February and a large deterioration in consumer confidence would reduce appetite for borrowing and, notably, bigticket purchases. Consumer confidence would be worsened further if the Bank of England continues to raise interest rates as implied in its recent rhetoric. Furthermore, in light of changes to stamp duty rates and tax relief changes, an extended decline in demand from buy-to-let investors may materialise. Weakness in overall mortgage lending and property transactions in the opening months of 2018 is likely to be accompanied by a significant slowdown or fall in house price growth and a decrease in house building starts would then be expected to follow. Private housing starts may fall away relatively quickly in response to any deterioration in the general housing market but output and completions would be expected to hold up initially as house builders destock, but fall from late In the case of all downside risks materialising, the performance of private house building will vary considerably from the central forecast. Under these conditions, starts would be expected to fall 5.0% in 2018 and 4.0% in Upside Risks: UK economic activity avoids marked slowdown Consumer confidence maintained in line with economic growth and a rise in real wages Mortgage lending and property transactions rise in 2018 House price growth continues at current rates If economic growth, wage growth and demand for home ownership remain strong against a backdrop of uncertainty and rising inflation, then mortgage lending, property transactions and house prices would be expected to pick up in This is especially the case given reported reductions in the supply of pre-owned properties on the market. There is also the potential for government policy measures on garden cities to provide an earlierthan-expected boost to house building in This would result in growth in starts of 5.0% in both 2018 and Private Housing Output million Constant Prices 35,000 30,000 25,000 20,000 15,000 10, % -2.4% 9.4% 25.3% 10.3% 13.3% 5.0% 3.0% 2.0% 5, e 2018f 2019p Source: ONS, Construction Products Association 24

25 25

26 Private Housing RM&I The prospects for private housing rm&i activity in the near-term depend on how consumer confidence and, importantly, households willingness to make large, discretionary purchases, are maintained as rising inflation has eroded increases in wages and salaries since early introduction of a 3.0% stamp duty surcharge for the purchase of additional properties. This led to property transactions rising 19.3% in quarterly terms and 32.5% in annual terms in 2016 Q1 as purchases were brought forward to avoid the higher transaction cost. This spike in purchase activity is likely to have driven the pickup in rm&i output growth in the second half of However, UK Finance forecasts that property transactions will remain around 1.22 million per year in 2018 and 2019, limiting the contribution to rm&i growth. The Royal Institution of Chartered Surveyors (RICS) has been reporting a shortage of existing properties for sale, and one sector of the rm&i market cited as providing impetus to growth is non-movers opting to extend or improve properties instead of moving, either due to not gaining enough equity to move up the housing ladder or, more significantly, retired, outright homeowners who have benefited from long-term rises in housing wealth and do not wish to downsize. The key factors that drive activity in the sector, particularly for improvements, are property transactions and consumer spending on big-ticket items. In addition, increases in housing wealth and household savings enable activity in the sector as they are used as sources of finance for rm&i activity. 21.4% of the English private housing stock does not meet the Decent Homes standard Property transactions are a key determinant of activity in the sector because improvements to an existing property, as opposed to new build, tend to be made with a typical lag of 6-9 months after purchase. Property transactions have remained around 1.22 million per year since 2014, but were distorted in the first half of 2016 by the In terms of funding streams for rm&i work, the household savings ratio has steadily declined from 10.7 in 2010 and 2011 to an average of 4.8 in the first three quarters of In addition, households are taking advantage of low mortgage interest rates to repay housing equity instead of using it as a source of finance. In 2017 Q3, 5.9 billion was repaid by households, in contrast to the pre-recession period when similar levels were being withdrawn from housing equity and used as funding for improvements work. Along with reduced savings and net housing equity repayment, consumer price inflation has risen faster than growth in wages since February 2017 and any further deterioration in real wages during 2018 is likely to have a large impact on consumer confidence, especially for purchases of big-ticket items. The Bank of England raised interest rates by 0.25 percentage points in November The impact of a single interest rate rise is expected to be limited, but the Bank has indicated a further tightening in monetary policy is likely over the next couple of years, which may have a negative impact on consumer confidence. 26

27 Private Housing RM&I Output 25,000 million Constant Prices 20,000 15,000 10,000 5, % -4.9% 2.3% 9.6% 3.2% 7.1% 7.0% 0.0% -2.0% e 2018f 2019p Source: ONS, Construction Products Association In terms of energy-efficient retrofitting work, a oneyear transition programme towards a four-year programme of the ECO: Help to Heat programme began in April The programme is valued at around 640 million per year and focuses on fuel poverty. This is lower than the 870 million spent under ECO previously and shifts focus from energy efficiency. Given its smaller scope, activity under the ECO: Help to Heat scheme is likely to be lower than its predecessor, in particular during the transition period. In the first eight months of the programme, the number of measures installed has averaged 14,718 per month, compared to a monthly average of 41,375 measures over the previous four-year ECO programme. On balance, these factors are expected to hinder output from the private housing rm&i sector in Momentum in output growth is expected to slow in early 2018 but a decline is forecast in the second half of the year, reflecting the lagged effect of falls in real wages hindering big-ticket spending. Activity is, therefore, forecast to remain flat in A 2.0% decline is then forecast in Downside Risks: Consumers retrench spending quickly in response to higher inflation An overall fall in property transactions in 2017 and house price falls in 2018 The full implementation of ECO: Help to Heat is delayed as has happened with previous supplier obligations A sharp deterioration in consumer confidence due to falling real incomes or a rise in economic uncertainty could result in households taking a precautionary savings stance and cutting nonessential spending. Whilst this is unlikely to affect basic repairs and maintenance, it could have a large impact on refurbishment work, especially in the near-term. In terms of energy-efficient retrofit work, the ECO focus on fuel poverty and any potential delay in the rollout of the full ECO: Help to Heat scheme in 2018/19 could lead to a further drop off in activity. In this case, output would be expected to decline 3.0% each year in 2018 and Upside Risks: Rising inflation has limited impact on consumer confidence Property transactions increase in 2018 House price inflation continues at current rates If UK consumer spending is unaffected by rising inflation, property transactions increase in 2018, and national house price growth remains around 5.0%, the prospects for rm&i remain positive. Whilst UK economic growth is still expected to be below the long-term trend in 2018, rm&i activity could accelerate as rises in transactions drive an increase in property refurbishment and improvements spending. This would drive growth rates of 2.0% in both 2018 and

28 Public Housing Greater certainty over grant funding and flexibility under the Shared Ownership and Affordable Homes Programme (SOAHP) had been expected to drive an increase in public housing activity in However, starts in England were 0.1% lower in the first three quarters of the year, following two previous years of declines in 2015 and The weakness was led by housing association starts, which were 2.0% lower over the period. Grant funding of 4.7 billion has been set aside for the SOAHP for England and an initial 1.3 billion in grants was allocated in January 2017, to 157 registered providers to build 39,403 units, plus an additional 7,131 units to be built under the programme without grant funding. A further 1.3 billion of funding and an undetermined share of 1.4 billion funding for public housing starts (announced in Autumn Statement 2016) were also released for bids on an ongoing basis. In addition, at the Conservative Party Conference in October 2017, the government announced an additional 2.0 billion funding for social housing. Limited detail on the policy suggests that it will fund 25,000 affordable rent homes in the final years of the parliament in 2020/21 and 2021/22. The government has allowed greater flexibility over the tenure of housing built under the SOAHP to include affordable rent, which is less dependent on general housing market conditions than shared ownership, which was expected to account for 88% of building under the programme previously. This is an important concession, given that during the 2016/17 financial year, the Homes and Communities Agency (HCA) reported that housing associations revenues from open market and shared ownership sales were below forecast in every quarter. Furthermore, the HCA s survey of private registered providers for 2017 Q3 showed that the stock of unsold shared ownership units has risen in every quarter since 2016 Q3. For local authorities, the Housing White Paper published in February 2017 confirmed the government s view that councils roles in house building will be to assign land and monitor delivery against local plans. The Local Government Association also warned that local authority building capacity is constrained by Right to Buy. Approximately two-thirds of receipts from Right to Buy sales are returned to the Treasury, leaving little to fund replacement building after the cost of sales and servicing of debt are also subtracted. In London, Autumn Statement 2016 also announced 3.15 billion for 90,000 affordable housing starts in London by 2021, which implies 22,500 per year. However, affordable starts in London totalled 8,935 in 2016/17, similar to the five-year annual average of 8,983 starts. 1.7 billion of the funding pot was allocated in July 2017, for 49,398 homes for social rent, London living rent and shared ownership. An 8.0 billion deal between housing association L&Q and the Mayor of London was also signed in April 2017, to build 20,000 new homes in the capital, 40% of which will be for market sale or rent. The Mayor of London published a draft housing strategy (also included in the London Plan) for the capital in September, which, in contrast to the Housing White Paper, encourages house building by local authorities, through lobbying central government for fewer restrictions on council borrowing, as well as joint ventures and partnerships. Flexibility to adjust tenures in accordance with prevailing housing market conditions, combined with a potentially large funding impetus for public house building in London, underpin the forecast for starts to increase 2.0% in 2018 but remain flat in Downside Risks: Difficulties in raising finance for housing associations A weakening in the housing market undermines focus on market-linked products Housing associations borrowing capacity has been reduced by the annual 1.0% cut to social rents implemented from April Ratings agencies have warned that this, alongside lower levels of grant funding and a greater reliance on marketlinked housing will worsen housing association creditworthiness. In addition, reduced investor appetite may also disrupt alternative methods of finance, such as bond issuance, where uncertainty 28

29 Public Housing Starts and Completions Great Britain Actual Actual Estimate Forecast Projection Starts Completions Output ( m) RM&I Output ( m) 32,835 32,367 31,396 32,024 32, % -1.4% -3.0% 2.0% 0.0% 37,004 31,230 34,353 34,697 35, % -15.6% 10.0% 1.0% 1.0% 5,049 4,814 5,295 5,454 5, % -4.7% 10.0% 3.0% 3.0% 8,141 7,680 7,296 7,150 7, % -5.7% -5.0% -2.0% 5.0% Source: MHCLG, ONS, Construction Products Association means that long-term returns on investment are unclear. Any changes to the planned tenure mix of development away from market-linked products is likely to delay start dates as housing association business plans are changed. These factors provide the downside risks to the forecast and would see starts decline 2.0% in 2018, before remaining flat in Upside Risks: Flexibility to increase housing built for affordable rent Open market demand for housing remains buoyant Over one-quarter of housing association starts and completions were for the open market in 2015/16 and 2016/17 and if underlying demand remains buoyant for market sales, market rentals and shared ownership products, this could cushion the fall in social housing construction activity by housing associations. If, in contrast, market conditions deteriorate and housing associations can quickly adjust business plans to accommodate a larger proportion of rental tenures instead of sales, starts would be expected to increase 4.0% each year in 2018 and Public Housing Output 7,000 million Constant Prices 6,000 5,000 4,000 3,000 2, % -16.3% 6.6% 31.9% -16.2% -4.7% 10.0% 3.0% 3.0% 1, e 2018f 2019p Source: ONS, Construction Products Association 29

30 Public Housing RM&I The majority of activity in the public housing rm&i sector is either basic repairs or essential maintenance on the existing public housing stock of 2.0 million local authority homes and 2.8 million housing association dwellings in Great Britain. This type of work cannot be delayed for a significant period of time. Sector output has fallen 19.5% since 2010 Q2, due to central government reducing funding to the Department of Communities and Local Government under its programme of fiscal austerity and, more recently, housing associations increasingly carrying out r&m in-house. This means that some work may not be captured in the ONS output data, which is based on a survey of contractors. A weak outlook for the sector in 2018 is based on financial constraints on local authorities continuing and the 1.0% annual cut in social rents until 2019/20 leading to reduced discretionary spending on maintenance and improvements by housing associations. However, following the Grenfell Tower disaster in June, the typical drivers of rm&i work in the sector will be replaced by a shift in focus towards fire safety, investigations and a review of the housing stock. The response of local authorities to the disaster suggests that public sector rm&i resources will be redirected to prioritise fire safety measures for high-rise social housing towers, yet with the results of fire investigations and a public inquiry pending, the full scale of the issue and, therefore, future works required is unknown and extends beyond the scope of the forecasts. The forecasts do take into account that emergency measures will need to be carried out as a priority on the public housing stock and are likely to displace other planned repairs and maintenance activity. Main work is not expected to accelerate until 2019, given the wide scope of pending investigations. Questions remain over funding for work, however, with local authorities asked to approach central government if financial constraints limit their ability to spend on fire safety work. The extent of future government funding for these works is unknown at this point. According to the Homes and Communities Agency (HCA), housing association spending on major repairs decreased by 14.0% in 2016/17 and it forecasts a continued fall throughout the duration of the social rent cut to 2019/20. Rm&i on social housing has also been affected by a reduction in the number of measures installed under the Energy Companies Obligation (ECO) and the cancellation of the Green Deal in July The current ECO programme ended in March and its successor, ECO: Help to Heat, began in April as a one-year transition programme before it begins fully in 2018/19. Under the Help to Heat programme, running until 2021/22, the focus will shift from improving energy efficiency Public Housing RM&I Output 10,000 million Constant Prices 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2, % 2.2% -4.1% 2.7% 1.9% -5.7% -5.0% -2.0% 5.0% 1, e 2018f 2019p Source: ONS, Construction Products Association 30

31 to reducing fuel poverty and the annual funding for the scheme will be cut from 870 million to 640 million. In the first eight months of the transition between ECO and ECO: Help to Heat, an average of 14,718 measures were installed per month. This compares to an average of 41,375 per month throughout the four years of ECO. Furthermore, the public housing stock is likely to be diminished through the increased uptake of Right to Buy. The policy is also expected to be extended to housing association tenants, with a pilot set to begin in the Midlands in July. The government s proposals for local authorities to sell off their high-value housing assets as a means of funding the policy will not be introduced until after 2018/19, however. The government has pledged a 1:1 replacement of homes sold through the Right to Buy, but between the second quarter of 2012 and the third quarter of 2017, there were 60,422 Right to Buy sales in England, but only 13,030 direct replacements started over the same period, a ratio of one replacement for every five sold. Any uptick in urgent repair work in the first half of 2018 is unlikely to offset the decline in output that has occurred in consecutive quarters since 2015 Q4. Output is estimated to have fallen 5.0% in A 2.0% decline is forecast for 2018, with growth picking up to 5.0% in 2019 as remedial work on the social housing stock accelerates. Downside Risks: Full implementation of ECO: Help to Heat programme delayed Local authorities direct funding away from housing rm&i Housing association revenues reduced by a weaker than expected housing market After the transitionary period in 2017/18, the full launch of a four-year ECO: Help to Heat programme is due to start in April. Delays to implementation, due to discussions over the scope and cost, cannot be ruled out, as has happened with previous programmes, and would reduce activity. The risk of further reductions in funding, through local authorities adjusting local spending priorities or a weaker housing market performance affecting housing associations open market sales revenues, also pose a downside risk to rm&i spending. Public housing providers may also decide to rm&i spending until the full scale of wider remedial work required is known. Under these conditions, output is forecast to decline 5.0% in Despite higher planned volumes of work for 2019, skills shortages would be expected to limit growth to 2.0% in Upside Risks: 17.4% of the English social housing stock was built before 1945 Housing associations focus on maintenance Housing market performs stronger than expected If building homes for market sale or shared ownership becomes less financially viable due to a weaker housing market moving into 2018, housing associations may instead focus on maintaining their existing, revenue-earning housing stock. Conversely, if the housing market remains more buoyant than expected, this would raise the revenues housing associations receive from sales of shared ownership and units sold on the open market, offering additional funding for rm&i work. This would help to offset constrained local authority rm&i spending and growth of 2.0% would be expected in 2018, followed by an increase of 5.0% in 2019, in line with the central scenario. 31

32 Public Non-housing Public non-housing construction output is largely determined by capital funding allocated to departmental budgets by central government and, therefore, is less affected by uncertainty than other sectors such as commercial and industrial. Public Non-housing Output by Sub-sector 2016 (%) Health 18% Entertainment 6% Other 21% As a positive for the sector, capital investment for health was increased in the Autumn Budget in November, following an additional funding allocation for new free schools in the March Budget. However, new orders for education, health and other sub-sectors (such as defence) decreased in the first three quarters of 2017 and combined with hospital projects completing, concern over potential delays and budget overruns and recent rises in raw materials costs, limit nearterm prospects for the overall sector. Output is expected to decrease 2.2% in 2018 before rising 0.7% in Education 55% Source: ONS The underlying driver of output in the publiclyfunded education sub-sector continues to be the Priority School Building Programme (PSBP). The first phase, nearing completion, will rebuild 260 schools, 214 of which are publicly funded. The 32

33 Public Non-housing Output 16,000 14, % million Constant Prices 12,000 10,000 8,000 6,000 4, % 0.2% 3.6% -9.6% -0.9% -1.4% -2.2% 0.7% 2, e 2018f 2019p Source: ONS, Construction Products Association Department for Education estimates that 23 will run over into 2018, however, due to site difficulties or planning issues. The 2.0 billion second phase (PSBP2) focuses on rebuilding individual blocks at 277 schools by Rising cost pressures for contractors were highlighted in a report from the National Audit Office as a threat to achieving time and budget targets for the PSBP2. In total, the PSBP was assessed to be 286 million over budget. A programme of new free schools, which are publicly-funded but operate outside of local authority control, has been favoured by government since The Conservatives manifesto in early 2015 pledged 500 new free schools by 2020, providing an additional 270,000 school places. Since then, 124 free schools have opened, with a further 376 approved, and a budget of 1.4 billion per year between 2016/17 and 2020/21. The government allocated 320 million in additional funding for 140 new free schools in the March 2017 Budget, although the majority is not expected to be used until Whilst some of the premises for free schools are conversions or refurbishments of existing buildings, in February 2017, the National Audit Office highlighted that the low availability of sites is a key constraint on the new build element. The Department for Education will need to spend 2.5 billion to purchase land for the free schools in the current pipeline, but bidding has exceeded official valuations by 60% on 20 sites so far. The Public Accounts Committee has also cited concerns over value for money with the free schools programme. The Autumn Budget in November 2017 reduced the Department for Education s capital investment funding by a cumulative 1.0 billion between 2017/18 and 2020/21 compared to the March Budget, but the government has subsequently selected contractors for an 8.0 billion schools construction framework running for four years from the end of As the Welsh Government s 1.4 billion 21st Century Schools programme ends in 2018/19, a second phase backed by 2.3 billion funding will begin in April 2019, but will be split between capital funding and the mutual investment model, a new form of public-private partnership. New orders decreased in every quarter (in annual terms) between 2014 Q4 and 2017 Q2. In 2017 Q3, new orders declined 6.2% on a four-quarter total basis. This weakness underpins a forecast of output falling 5.0% in 2018 and remaining flat in 2019 as initial work under new programmes begins. The Infrastructure Projects Authority s Delivery Confidence Assessment has rated the Priority School Building Programme as amber : successful delivery appears feasible but significant issues already exist. 33

34 Downside Risks: Cost increases and a lack of contractor interest delay start dates further If contractors are reluctant to sign contracts for work due to cost inflation, the start and end dates for PSBP2 work could be pushed further beyond the forecast horizon, whilst start dates for future schools construction programmes in England and Wales may also be delayed. In addition, it is unlikely that the government will assign additional funding to cover these higher costs across each year of the programme, leading to a delay in contract awards and the start of construction. In this case, output is expected to decline 6.0% in 2018 and 3.0% in Upside Risks: Capital funding is brought forward Additional financial support for school building is only likely to arise if government brings forward funding from later years of the departmental budget to 2018/19, as a means of covering higher cost pressures in the near-term and providing confidence over start dates for new building programmes. Output would rise 3.0% each year in 2018 and 2019 in this case. Like education, the health sub-sector has also experienced sharp falls in output and new orders in recent quarters. Work in this sub-sector includes publicly-funded work on hospitals, health centres and clinics. Among projects currently underway are the 298 million Broadmoor redevelopment in west London (opening early 2018), two 136 million proton beam treatment centres in London and Manchester (completion in 2018) and the 480 million Royal Sussex County Hospital, where work is expected to continue to The 90 million redevelopment of the Royal National Orthopaedic Hospital in London started in early 2017 after the originally privately-funded project was assigned capital funding from the Department of Health in August In addition, the 160 million redevelopment of Springfield Hospital, on two sites in south London, saw contracts awarded at the end of The latest NHS smaller works framework, the 4.0 billion ProCure22, started in October 2016 and will provide a stream of work over the next few years. Between its start date and January 2018, 41 major works schemes and 19 small works packages have started under ProCure22. Capital value of projects in the ProCure22 pipeline: 1.7bn The Department of Health was allocated 6.1 billion for capital investment in 2017/18 in the March Budget and the November Budget increased funding for each subsequent financial 34

35 year to 6.4 billion in 2018/19, 6.7 billion in 2019/20 and 6.8 billion in 2020/21, although it is unclear how much of the capital budget will be assigned to new building work, rather than IT upgrades and equipment. The outlook for 2018 is weak as work on large hospitals projects peaks or completes and the pipeline is not replenished at the same rate. Sub-sector output declined 26.6% in 2017 Q2 and 35.4% in Q3, whilst new orders were 44.6% lower on a four-quarter basis in Q3. Output is forecast to decline 8.0% in 2018 and rise 1.0% in Downside Risks: Cost rises delay projects Rising costs for raw materials and on-site labour may lead to delays as projects are paused to allow for attempts at contract renegotiation. The cancellation of plans for a 336 million critical care hospital near Basingstoke in December also demonstrate a low appetite for high-value projects. Cost-related delays in publicly-funded activity would lead to a fall of 10.0% in 2018 and output remaining flat in Upside Risks: Capital funding is brought forward Like the education sub-sector, a sharp rise in costs that leads to contractors pausing activity could also prompt the government to change the existing capital funding profile. The increase in annual capital funding for the Department of Health already allocated in the Autumn Budget suggests that the only option would be to bring forward spending from later years. Growth of 2.0% each year in 2018 and 2019 would then be expected. Public non-housing other covers construction work on publicly-funded facilities such as prisons and defence projects. In 2017 Q3, output grew 35.7% on a four-quarter basis as two large defence projects entered the pipeline: the 500 million, tenyear upgrade to the Faslane naval base in Scotland, which began in early 2017, and the 135 million works at RAF Marham in Norfolk, including a new aircraft hangar and runway and taxiway resurfacing works, with work required to be completed before new aircraft come into service in mid In addition, the award of contracts for the Ministry of Defence s 1.1 billion accommodation and facilities for the Army Basing Programme on Salisbury Plain will improve growth rates from 2018, ahead of the project s completion in The Autumn Budget confirmed the Ministry of Defence s capital budget allocation from March, which was increased to 8.5 billion in 2017/18 (from 7.5 billion previously), 8.7 billion in 2018/19 ( 7.8 billion previously) and 9.0 billion in 2019/20 ( 8.1 billion in Budget 2016). In terms of prisons projects, there is little in the Ministry of Justice construction pipeline aside from the expansion of Rye Hill and Stocken prisons. In March, the government announced further detail of four new prisons to be built in Yorkshire, Wigan, Rochester and Port Talbot as part of its 1.3 billion investment in the prison estate, but so far, only one (Full Sutton in Yorkshire) has received outline planning permission. Therefore, construction work is likely to fall outside of the forecast period. The first 500 million tranche of work under the 1.0 billion Government Hubs programme, which seeks to reorganise public sector offices into regional hubs, mainly through fit-out work, was awarded in June 2017 and would be expected to provide some work from New orders in the subsector rose 29.8% on a four-quarter basis in 2017 Q3, with output expected to rise 5.0% in 2018 and 2.0% in Downside Risks: Delays to projects Questions over contractor appetite may arise if prolonged uncertainty acts a stronger drag on economic growth over the next 12 to 24 months. In addition, contractors may pause to renegotiate contracts to take account of rising costs, forming the main downside risks to sub-sector activity, which would see output fall 2.0% and 3.0% in 2018 and 2019 respectively. Upside Risks: Further detail and contracts for new prisons Full planning approval for the four new prisons announced in March 2017 would increase certainty for the sub-sector. However, construction activity would not be expected to begin until late 2018 at the earliest, to allow for design and tendering. Therefore, output growth of 7.0% would be expected in 2018 and 5.0% in

36 Public Non-housing R&M Output in the public non-housing repair and maintenance (r&m) sector consists of basic repairs and maintenance carried out on schools, hospitals and other public buildings. 6,000 Public Non-housing R&M Output 6.0% 2.5% million Constant Prices 5,000 4,000 3,000 2, % -2.7% -11.9% -1.4% -1.0% -2.0% 0.0% 1, e 2018f 2019p Source: ONS, Construction Products Association Basic repairs and maintenance cannot be cancelled or postponed significantly, which means that activity in the sector is less volatile than in public non-housing new build, in spite of cuts to departmental funding since Against a backdrop of reduced grant funding from central government, and financially-constrained councils, output in the sector decreased in every quarter since 2016 Q3 and a full-year contraction of 1.0% is estimated for 2017, followed by a further 2.0% contraction forecast for 2018 and output remaining flat in The schools Property Data Survey and the Royal Institute of British Architects estimate a backlog of repairs to school buildings of between 6.7 billion and 8.5 billion. The government assigned 4.2 billion in school condition funding between 2015 and 2018, alongside more recent top-ups including a 1.4 billion investment to help improve and maintain the condition of school buildings and a 216 million investment for school maintenance announced in the March 2017 Budget. However, the condition of the school estate is expected to deteriorate further despite planned investment and the cost to return schools to satisfactory conditions is likely to double between 2015/16 and 2020/21, according to the Department for Education s own estimates. Prior to its liquidation, Carillion held facilities management contracts for 875 schools and was the largest provider of facilities management services to the NHS and the Ministry of Defence. The government has confirmed that the contracts on the public sector services side of Carillion s business will continue and, therefore, the effects of the liquidation on public non-housing rm&i are expected to be minimal. Downside Risks: Local authorities cut spending plans Direct funding from central government is cut to focus on new build In the event of a further reduction in local authority spending power, due to budget tightening by councils or central government shifting funding profiles to focus on new build, this could lead to output contracting 4.0% each year in 2018 and Upside Risks: Work on framework contracts limits falls in activity Existing long-term contracts for maintenance on prisons and hospitals are less likely to be affected by economic uncertainty and will provide a steady stream of public non-housing r&m activity. However, even with this support, growth in the sector is expected to remain flat in 2018, before growth of 1.0% in

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38 Commercial Commercial activity peaked during the first half of 2017 based on new orders signed prior to the EU referendum. Commercial Output by Sub-sector 2016 (%) Entertainment 21% Retail 16% Other 26% Offices 37% Education 17% Health 4% Garages & Misc 5% Source: ONS Activity still remains at historically high levels as commercial sector output rose by 7.3% in 2016 to 28.1 billion and it is estimated to have increased by a further 3.0% in 2017, based on the ONS s revised output data for the year. However, output has fallen away since Summer 2017 and output in the third quarter of 2017 was 3.2% lower than in the second quarter. As noted in previous forecasts, the EU referendum marked a clear break between certainty in the sector and fortunes looking forward. Prior to the referendum, there were already concerns regarding the commercial market peaking and high prices being quoted for potential commercial investors, especially in London. Despite this, new orders remained at a high level. Commercial new orders in the first quarter of 2016 were 11.6% higher than one year earlier and new orders during the second quarter of 2016 were 28.7% higher than one year earlier, boosted in particular by projects in the capital, Manchester and Birmingham. Following the EU referendum in June 2016, uncertainty regarding the future economic prospects and the relationship with the EU appeared to act as a hindrance to high up-front investment in commercial for a long-term rate of return. International investors and developers adopted a more risk-averse strategy towards new projects. New orders in the third quarter of 2016 were still 6.1% higher than a year earlier but 11.3% lower than in the second quarter of 2016 and gave an initial pointer towards falls in new orders to come. This decline in orders accelerated in the final quarter of 2016, in which new orders were considerably lower on a quarterly and annual basis. New orders in the final quarter or 2016 were 11.8% lower than in the third quarter of 2016 and 24.1% lower than a year earlier. Furthermore, during the first three quarters of 2017, new orders were 11.1% lower than during the first three quarters of Overall, output is expected to fall by 5.0% in 2018 and 1.4% in 2019 as the fall in orders feeds through onto the ground. The direct impact of the demise of Carillion on the commercial sector would be expected to be relatively small if government and the receiver PwC can get work restarted on the two PFI hospitals. Carillion conducts around 350 million of commercial work annually in a sector valued at 28.1 billion in Although it is involved in the high profile projects at Kings Cross in London, for Google, and at Paradise Circus in Birmingham, other contractors are also involved. There is, however, more uncertainty regarding the Vaux Brewery development Phase I and the Tower Works redevelopment. Offices construction to decline by 15% during 2018 and 10% in 2019 Output in the offices construction sub-sector rose by 12.3% in In addition, offices output in 2017 Q1 was 1.7% higher than in 2016 Q4 and was 3.8% higher than one year earlier. However, 2017 Q2 saw output fall by 2.7% on both a quarterly and annual basis. Activity still remains at a high level, especially in Manchester, but the falls in 38

39 Commercial Output 30,000 25, % 0.0% 6.3% 2.7% 7.3% 3.0% -5.0% -1.4% million Constant Prices 20,000 15,000 10, % 5, e 2018f 2019p Source: ONS, Construction Products Association new orders from 2016 have clearly been starting to feed through onto the ground and output in the third quarter of 2017 was 7.4% lower than in 2017 Q2 and 8.8% lower than one year earlier. In 2016, new orders rose by 0.6% yet this masks the sharp falls in offices new orders postreferendum, since the second half of the year and new orders compared with a year ago have fallen for the last five quarters. New orders in the third quarter of 2016 were 5.8% lower than one year earlier and orders during the fourth quarter of 2016 were 29.7% lower than a year ago. More recently, offices new orders have continued to be lower than a year ago throughout last year. New orders in 2017 Q1 were 22.1% lower than a year earlier and new orders for offices in 2017 Q2 were 26.8% lower than a year ago. The most recent orders data highlights that offices new orders in 2017 Q3 fell below 1.0 billion per quarter and were 17.2% lower than a year ago. Overall, the new orders data suggests that output will fall sharply in 2018 and Office construction down by 9% over the past six months to 12.6m sq. ft. 39

40 The Deloitte Crane survey for Winter 2017 reports that the current level of office construction activity across central London totals 12.6 million sq. ft., which represents a 9.0% fall over the past six months and the second consecutive fall in the biannual survey although activity remains above the long-term average. The survey recorded 25 new office development starts, which is half of the number recorded at the beginning of 2016, prior to the EU Referendum. In addition, the volume of new space starting was only 1.8 million sq. ft., the lowest level since the 2014 survey and 21.0% below the survey average. In addition, Deloitte reported that of the activity in 2017 Q3, only 30.0% was new build and 70.0% was refurbishment of existing offices facilities. The financial sector continues to account for the largest share of office space under construction at 45.0% (2.5 million sq. ft.) in London, the same share as six months earlier. However, the corporate sector now represents 24.0% of let space, which is double the figure six months ago, primarily due to the expansion of flexible working offices space providers. This accounts for 670,000 sq. ft. across only seven schemes, which is greater than the Technology, Media and Telecoms (TMT) sector. In addition, according to estate agency group Cushman & Wakefield, the flexible offices space provider WeWork, has rented more space in Central London since 2012 than any other company, leasing 2.6m sq. ft. of space, which has made WeWork the biggest occupier of offices in the capital after the UK government. However, this does raise questions about the sustainability of this growth given that WeWork is a relatively new startup expanding at a time when offices demand and offices construction in Central London is falling sharply, albeit from a high point. Despite the pessimism in the London offices construction market, demand continues to outstrip supply in the Manchester offices market. In particular, the supply of Grade A offices space remains at historic lows and is expected to remain so in spite of around 500,000 sq. ft. of new offices space expected to complete in the next six months. In Manchester, demand from TMT appears strong and in 2017 Q2, the TMT sector was the most active occupier group, accounting for almost half of the total take-up of offices space according to Knight Frank. In addition, flexible workspace 40

41 providers, which use shorter-term tenancies than traditional landlords, have increased take-up across large cities around the country. The proportion of total take-up of offices space by flexible office groups rose from 2.0% in 2016 to 7.5% in In spite of growth in offices activity in cities outside the capital, given the current declines in activity over the past 6-9 months and poor levels of new orders, offices output is expected to fall throughout the year and, overall for 2018, fall by 15.0% before a further fall of 10.0% in Downside Risks: Prolonged Brexit negotiation uncertainty Business investment is constrained by a longer economic downturn, which reduces pre-letting activity and investor confidence Further depreciations in Sterling lead to further rises in construction costs Uncertainty throughout the Brexit negotiations would be expected to lead to sharper falls in the investment and take-up of new high-profile office space in London. Uncertainty regarding financial passporting and the UK s participation in the Single Market would particularly impact upon the financial sector and lead to further falls in new investment in London. In addition, any further depreciations in Sterling due to speculation would lead to a rise in construction costs, due to the impact on imported materials, hindering the financial viability of projects given uncertain returns. In this case, commercial offices would be expected to fall 20.0% in 2018 with a further decline of 15.0% in Upside Risks: Stronger economic growth despite rising inflation Exchange rate weakness supports foreign investment If the economy returns to robust growth and real wage growth is maintained, despite rising inflation, then upward revisions to business confidence and business investment may incentivise new investment in commercial offices. This, combined with a weaker value of Sterling, may lead to further international investment as concerns regarding long-term returns on investment abate. These potential new projects could help to offset the impacts of falls in new contract awards last year. In this case, activity would remain flat in 2018 and Little has changed in the CPA forecasts for the retail sub-sector. Whilst there remain hives of activity, the long-term issues remain subdued spending constrained by real wage falls and poor consumer confidence, combined with the trend away from the high street towards online shopping. In addition, 2018 is likely to see retailers suffering from the impacts of the recent business rates revaluation. As a result, output is expected to fall this year before four years of consecutive falls in sector output are halted, at a historic low level mainly by two major projects in London. The occupational market for retail remains subdued. There are very few new entrants keen on taking large new high profile space. New occupiers from Continental Europe appear to prefer landmark locations such as Oxford Street or Westfield in London. Outside of the capital, tenants generally appear to be more cautious given an excess supply of existing space but in cities such as Manchester, Birmingham and Leeds, activity still remains buoyant. In addition, demand for retail space still appears to be strong in key areas of the South East such as Kingston and Guildford. This may partially offset falls in demand in other parts of the country. One of the main areas of growth over the past 12 months had been in out-of-town retail, driven by cash-constrained local authorities in addition to overseas buyers purchasing commercial retail for investment purposes. However, given concern regarding local authorities exposing themselves to risky investments, Knight Frank expect the 41

42 Lidl continues its government to put in place legislation to ensure that councils are not exposed to risky commercial investments. Furthermore, given the current level of uncertainty, it is highly unlikely that activity from international investors will offset the fall in demand from councils billion UK investment plan Food retailers face highly contrasting fortunes. Discounters such as Lidl and Aldi continue to open new stores, although there are early signs of a slowdown in some regions as their acquisitions of new sites has slowed and, anecdotally, there is concern that they may be overexposed to slowing markets. However, in January, Lidl still announced that it will build a 1.0 million sq. ft. regional distribution centre in Hertfordshire as it continues its 1.5 billion investment plan in the UK and, according to Barbour ABI, Lidl submitted 68 planning applications for new stores in 2017, which would be expected to be built out over the next 24 months. Asda and Morrisons appear to be increasing activity regarding new store acquisition although at this stage it is unknown whether this would be taking over existing buildings or new build. However, in the main, the primary focus of the largest four supermarkets will be on improving their performance across their existing portfolio. The 1.4 billion Croydon Partnership project finally given the green light by the Mayor of London The 1.4 billion Croydon Partnership project has been highlighted in CPA forecasts over the last few years. The Mayor of London gave his final approval in January 2018 and it will see the current Whitgift and Centrale shopping centres replaced by a larger, 1.5 million sq. ft. complex built by Westfield and Hammerson with construction expected to start in 2019 and it is expected to be completed in There have been no further developments on the 1.4 billion Brent Cross extension is expected to double the size of the shopping centre and allow for another 200 shops. The start of main works is expected towards the end of this year, although the key boost to activity is likely to occur next year. The project is expected to be completed in Overall, a decline of 5.0% is expected in 2018 before output returns to growth with a rise of 2.0% in 2019 driven primarily by work from Lidl and on the two 1.4 billion London projects. Downside Risks: More depreciations in the value of Sterling lead to further cost rises Lower real wage growth leads consumers further towards spending in low-value chains and online rather than major supermarket chains Further depreciations and increased volatility in the value of Sterling could lead to higher costs, falls in real wage growth and declines in consumer spending overall. In addition, falls in real wage growth could lead to further increases in the proportion of spending online. In this case, retail construction would be expected to fall 7.0% in 2018 and 5.0% in Upside Risks: Stronger than anticipated UK economic growth Consumers utilise savings in the short-term to still spend despite rising costs Real wage growth in the medium-term continues despite inflation rises In the short-term, consumers could maintain spending by utilising savings if they assume that the hit to real wage growth will be temporary. If UK economic growth is sustained at rates experienced in 2015 and 2016 and real wage growth continues as employers are able to raise nominal wages in line with inflation then consumer spending could be sustained in the medium-term. In this case, retail output remains flat in 2018 and rises 3.0% in

43 43

44 Output in PFI education rose by 9.4% in 2015 and by 11.1% in However, on revised data the ONS, output is estimated to have fallen by 3.0% in Until last year, activity had risen over the last four years and output in 2016 was almost double (98.9%) the level seen in This growth was primarily due to university expansion programmes highlighted in previous forecasts that are expected to be funded by rising student numbers, increasing student fees and an increasing proportion of foreign students. Bristol University borrowed 200m for a new campus Future growth in university revenue may, however, be hindered by the UK government announcing it was placing a cap on student fees in October In addition, the spectre of Brexit may hinder the number of EU students wishing to come to the UK and study, at least until conditions are more certain. Brexit may also hinder university borrowing and make it more expensive. Many of the improvements to facilities and accommodation across the universities sector have been partly financed by investment loans from the European Investment Bank (EIB) such as the 280 million 30- year loan to UCL. Brexit will not impact on existing loans but may have a major impact on any new loans taken out post-brexit. According to the data from the National Audit Office (NAO), the EIB provided one third of funding for PFI and PF2 infrastructure projects over the last four financial years. The proportion of funding for PFI and PF2 projects from the EIB increased from 28% to 43% between 2013 and 2017, an average of 33%. Overall, the EIB provided 758 million for 2.3 billion PFI and PF2 projects over the four years, the majority of which were PF2. The NAO stated that projects have become increasingly reliant on the EIB because of new banking regulations introduced in 2013, which reduced private financers involvement in long-term construction contracts. Overall, output is estimated to fall 2.0% in 2018 before remaining flat in Downside Risks: Rising construction costs hinder viability of projects The Department for Education already stated in 2016 that there was a 286 million cost overrun on the Priority School Building Programme. Further delays and cost overruns within the privately-funded part of the programme would put at risk the volume of work conducted or require further funding. In this case, output in the subsector would be expected to fall by 2.0% in 2018 and 3.0% in Upside Risks: Increased funding from non-eu students Further rises in student fees and rises in non-eu students could incentivise further university campus and accommodation investment. Output would rise 2.0% in both 2018 and 2019 in this case. 44

45 The prospects for the PFI health sub-sector have deteriorated in the last three months. Activity fell by 4.3% in 2016 and by an estimated 5.0% in 2017 due to a lack of major projects in the pipeline. In the last two forecasts, the CPA had highlighted the fact that output in 2017 was negatively affected by delays and cost overruns and rework on two of the very few major existing projects. However, these two are Carillion projects and work has completely stopped with the sites now secured. There are two PFI hospital projects in the system. The 450 million Royal Liverpool and Broadgreen hospital redevelopment, which in spite of its delays, was expected to finish in Summer Work on the first new major PF2 health project, the 350 million Midland Metropolitan Hospital began in 2016 and it was expected to open in Delays meant that it was expected to open in Spring 2019 but a review into lack of capacity and the potential need for an additional floor were likely to delay completion to Now, the uncertainty has only increased. At this point, with the sites closed on both projects, it is unknown whether work will be restarted as Carillion projects given existing staff and sub-contractors or, more likely, contracts will have to be transferred. At this point there are no further developments on the 165 million public-private partnership (PPP) Papworth hospital project at the Cambridge Biomedical Campus. It started in 2015 covering 40,000m 2 and will provide 300 beds when completed. It was originally scheduled for opening in April 2018 but this was delayed by five months in 2017 and the revised completion date is currently late However, further delays cannot be ruled out. The end of 2017 has seen two significant sized projects put on hold due to falls in demand for private healthcare. In September, the 500 million Spire Healthcare hospital in London was put on hold. This was due to a fall in NHS referrals to private hospitals and a fall in healthcare tourism as people outside the UK increasingly prefer to be cared for in their home countries. In November, Nuffield Health announced that it had put on hold the construction of a 70 million private hospital at the former Manchester Metropolitan University campus, again due to the impact of a lack of NHS referrals on current, and future expected, revenues. Overall, output is expected to fall by 2.0% in 2018 and remain flat in 2019 but the lack of a pipeline means that the forecast will be, primarily determined by what happens to the two main Carillion PFI projects and, as a consequence, the risks must be seen as on the downside. Downside Risks: Further delays to projects Rising construction costs hinder project viability Higher construction costs, resulting from the effect of Sterling depreciation pushing up the price of imported materials, or continued large increases in construction wages due to labour shortages, may lead to a pause in activity as contractors re-assess costs and margins. In this lower case, output would be forecast to fall by 1.0% in 2018 and Upside Risks: The number of private sector hospital projects increases Private healthcare providers have increased development in recent years and a small number of medium-size projects would be enough to drive growth in the sub-sector during both 2018 and 2019, of 1.0% and 2.0% respectively. Further delays on the 450 million Royal Liverpool and Broadgreen hospital redevelopment and 350 million Midland Metropolitan Hospital after the collapse of Carillion 45

46 Private Non-housing R&M Output in private non-housing repair and maintenance (r&m) includes the basic repairs and maintenance of offices, shops, warehouses, factories and other privatelyowned properties and is dominated by work on offices and retail units. The two key drivers of activity in the sector, business investment and consumer spending, have both slowed in recent quarters. In 2017 Q3, business investment increased 1.7% in annual terms, down from 2.5% in Q2 and 2.7% in Q1 and marked the lowest growth since 2016 Q2. The slowdown over the past three quarters is largely attributed to Brexit-related uncertainty weighing on business sentiment and decision-making, and this trend is expected to persist in the nearterm. Similarly, household spending increased 1.0% year-on-year in Q3, down from 1.4% in Q2 and was the slowest annual growth in nearly six years, reflecting the squeeze on household budgets from rising inflation and muted real wage growth. Although these pressures are expected to dissipate over the course of 2018 resulting in a modest pick-up in consumption, this is likely to be offset by weaker business investment growth and, as a result, no growth is expected in both 2018 and Overall, output in the sector tends to be less volatile, given the reliance on facilities management contracts. Carillion is the UK s second largest construction, facilities and property management company and, despite its liquidation in January, 90% of private sector clients have indicated they wish for service contracts to continue. As a result, the impact of its collapse on activity is expected to be limited. Downside risks: Weaker-than-expected growth in business investment and household spending A prolonged period of heightened uncertainty over the UK s future relationship with the EU and higher inflation is likely to weigh on business and consumer confidence in the near-term. In this case, consumers and businesses are expected to rein back spending and investment plans respectively, restraining activity in offices and retail. Under these circumstances, private nonhousing r&m output is expected to decline 2.0% in both 2018 and Upside risks: Consumer spending picks up as real wages recover Assuming the effects of the past depreciation of Sterling fade away quickly in the near-term, this poses an upside risk to the sector. Coupled with a recovery in real growth, if employers increase pay in response to above-target inflation, it is likely to boost consumer spending and, as a result, private non-housing output is expected to increase 2.0% per year in 2018 and Private Non-housing R&M Output 14,000 million Constant Prices 12,000 10,000 8,000 6,000 4, % 2.3% 3.6% 8.2% 4.1% 4.4% 1.0% 0.0% 0.0% 2, e 2018f 2019p Source: ONS, Construction Products Association 46

47 Industrial The overall outlook for the industrial sector remains weak, with output expected to decline 4.6% by 2019, despite improved prospects for warehouses. Looking at 2018, output in the sector is forecast to remain flat, an upward revision from a decline of 3.1% anticipated in the previous Autumn forecasts. Although activity in warehouses is expected to pick-up this year after two years of decline, this will be offset by a fall in the factories sub-sector, where activity will be constrained by slower domestic economic conditions and a limited pipeline of new work. As a result, industrial output is projected to contract 1.1% in By the end of the forecast period, industrial output is projected to total 4.2 billion, 0.2 billion lower than in Industrial Output by Sub-sector 2016 (%) Factories 56% Warehouses 44% Oil, Steel & Coal 0% Source: ONS Industrial output is forecast to fall % by 2019 Factories output is fundamentally driven by industrial production and manufacturing output, which, in turn are dependent on domestic demand and exports. In 2017 Q3, manufacturing output rose 1.3% quarter-on-quarter, after reporting a 0.1% fall in the previous quarter and marked the strongest quarterly growth rate since 2016 Q4. These figures are broadly consistent with recent industry surveys (Markit/CIPS and the EEF), which have pointed that output remains at multiyear highs, largely underpinned by healthy global economic conditions. In Q3, UK exports of goods increased 15.9% year-on-year to 86.8 billion, the fourth consecutive quarter of double-digit annual growth, supported by strong global demand and the past Sterling depreciation. However, such benefits to export competitiveness are expected to be short-lived, as the effect of the past fall in Sterling begins to fade and coupled with weaker domestic demand, this is likely to weigh on manufacturing activity. Furthermore, in Q3, new 47

48 orders declined 0.1% on four-quarter basis, which is expected to feed through to output. As a result, factories output is forecast to decline 4.0% in 2018 and 2.0% in In terms of activity on the ground, construction is currently underway on Aston Martin s 200 million manufacturing facility in South Wales and McLaren s 50.0 million factory in South Yorkshire. Furthermore, in November, as part of the Industrial Strategy, the government allocated 80.0 million from the 246 million Faraday Battery Challenge to build a new National Battery Manufacturing Development Facility (NMDF) in Coventry to support the development of electric batteries for Manufacturing output rose 3.3% year-on-year in Q3, the strongest in seven years the automotive sector. Despite the outcome of the EU Referendum in June 2016, major car makers have reaffirmed their commitments to the UK s automotive industry. Among the commitments are Nissan s expansion plans at its Sunderland factory, Honda s 200 million investment at its manufacturing centre in Swindon and 240 million from Toyota to upgrade its car plant in Derbyshire. However, ongoing uncertainty regarding the UK s future trading relationship with the EU is undermining business confidence, with other car makers still holding back investment decisions awaiting further clarity. Beyond the automotive sector, construction on Boeing s first European manufacturing facility in Sheffield and the world s largest corrugated cardboard manufacturing facility worth 75 million in Ellesmere Port is underway, with both due for completion by the end of Downside risks: Manufacturers delay or cancel investment plans Weaker-than-expected domestic demand Further depreciations in Sterling Heightened uncertainty surrounding the outcome of Brexit negotiations will inevitably make the UK a less attractive investment destination and, as a result, manufacturers may revise or delay major investment plans in the near-term. A marked slowdown in domestic demand as household spending weakens in response to higher inflation and subdued wage growth, poses another Industrial Output 6,000 million Constant Prices 5,000 4,000 3,000 2, % 9.5% -9.2% 16.0% 11.5% -6.8% -3.6% 0.0% -1.1% 1, e 2018f 2019p Source: ONS, Construction Products Association 48

49 downside risk to the sub-sector. Moreover, further falls in Sterling, alongside higher commodity prices, are likely to keep input costs elevated for manufacturers. In the medium to long-term, overall cost pressures faced by firms could be exacerbated assuming reduced access to labour from the EU, which would create additional recruiting costs. In this case, factories output is expected to decline 5.0% in both 2018 and Upside risks: A weaker Sterling exchange rate boosts exports further Stronger global economic growth Further falls in Sterling, alongside stronger global economic growth may boost exports of goods further in the near-term. However, such benefits to export competiveness are unlikely to fully mitigate the prospective weakening in domestic demand and, as a result, output is expected to remain flat in both 2018 and Activity in the warehouses sub-sector is primarily driven by UK economic growth and consumer spending, both having weakened in recent quarters. Latest data show that in Q3, the UK economy expanded at its weakest annual pace since 2013 Q1, whilst consumer spending growth reached its lowest in nearly six years. This was echoed in recent retail sales data, although the proportion of internet spending has continued to expand, reaching 18.0% in December due to the ongoing structural change taking place in the retail industry. This, in turn, has continued to underpin demand for warehouses and distribution space and, according to Savills, million sq. ft. of warehouse space was taken up by online retailers between 2016 and 2017, compared to 1.47 million sq. ft. recorded between 2008 and Healthy take-up levels, lower construction activity and robust demand over the past 12 months have continued to put upward pressure on rents, and this is expected to persist in the near-term. In 2017 Q3, new orders increased 71.8% in annual terms however, quarterly orders tend to be volatile, but on a four-quarter basis, were still 10.3% higher than a year earlier. This growth in new orders is expected to filter through to activity on the ground and, as a result, the CPA forecasts warehouses output to increase 5.0% in 2018, before remaining flat in Downside risks: A sharp slowdown in consumer spending Speculative development declines due to heightened economic uncertainty A major downside risk to sub-sector growth emerges if consumers rein back their spending sharply in the face of rising inflation and falling real wage growth. Faced with lower retail sales, retailers may cut back on expansions plans, denting demand for warehousing and distribution space. This, together with limited speculative development activity would result in lower growth rates over the next three years. Under these conditions, warehouses output is expected to remain flat in 2018, before falling 5.0% in Take-up of warehouse space by online retailers Upside risks: rose 731% (Source: Savills) Consumer spending picks up as real wage growth recovers If employers raise nominal wages in response to higher inflation, real wage growth is expected to recover over the near-term. However, the higher cost of living could see consumer spending habits shift more towards online retail in search for bargains, which in turn, would fuel demand for warehousing and distribution space further. In this case, we still anticipate output to increase 5.0% in 2018, followed by growth of 2.0% in between 2008 and

50 Infrastructure Infrastructure construction output forecast to increase 6.3% in 2018 and 11.1% in Infrastructure Output by Sub-sector 2016 (%) Infrastructure output forecast to rise 6.3% in 2018 & 11.1% in 2019 Electricity 43% Gas, Air & Communications 2% Rail 13% Harbours 3% Water & Sewerage 14% Roads 25% Over the next two years, activity will primarily be driven by work on large-scale infrastructure projects in the rail, water & sewerage and electricity sub-sectors such as HS2, the Thames Tideway Tunnel and Hornsea One. Even the relatively small harbours sub-sector will be boosted by projects such as the 350 million Aberdeen Harbour Expansion project. In December 2017, the government updated the National Infrastructure and Construction Pipeline, setting out billion worth of planned private and public investment over this Parliament, with billion worth of projects from 2017/18 to Source: ONS 2020/21. Furthermore, in the Autumn Budget 2017, the government increased the size of the National Productivity Investment Fund (NPIF) from 23 billion to 31 billion and extended it by one year to 2022/23. This included a new 1.7 billion Transforming Cities Fund to improve local transport connections. However, it is the delivery of these infrastructure announcements that will be key. By the end of the forecast period, infrastructure output is projected to total 21.9 billion, 4.1 billion higher than in

51 According to data from Barbour ABI, around 60% of Carillion s active schemes or projects with contracts awarded in which Carillion is the sole major contractor are infrastructure projects. Within their infrastructure work, 53% of the projects are road schemes and 42% of the projects are rail schemes. As a consequence, there would be expected to be a hiatus until activity can be restarted and this delay will be dependent upon the willingness of the key clients, Network Rail and Highways England, to continue with projects under previous contract conditions. Network Rail stated in January that it will pay the construction supply chain from Christmas and provide activity until at least mid- April. Some of the major contracts include work on HS2, electrification of key routes, road widening and bypass schemes, as well as work on Highways England s smart motorway programme. However, many of Carillion s projects are joint ventures with other major contractors and under the contract terms, the partner contractor(s) will take over Carillion staff and so work on these projects is likely to remain largely unaffected apart from small administrative delays whilst staff are moved over. In the longer-term, the National Audit Office (NAO) highlighted in January 2018 that the European Investment Bank (EIB) provided onethird ( 758 million) of the total 2.3 billion funding for PFI and PF2 infrastructure projects over the last four years. The proportion of funding for PFI and PF2 deals coming from the EIB increased from 28.0% to 43.0% between 2013 and The NAO stated that infrastructure projects have become increasingly reliant on the EIB due to new banking regulations in 2013, which reduced financial institutions involvement in long-term infrastructure deals. It is highly unlikely that this source of finance will be available once the UK leaves the EU in March 2019, or following an implementation period, and the UK government has yet to establish if and how this finance will be replaced. The near-term outlook for the rail sub-sector remains unchanged, with output forecast to increase 5.0% in 2018, driven by main construction works commencing on the 263 million London Overground extension to Barking Riverside, alongside ongoing works on the 1.2 billion Northern Line extension to Battersea and the Bank station capacity upgrade project. Construction on the latter is expected to reach completion in 2022, a year later than initially planned and the total cost of the project is now 642 million, 19 million higher than the 623 million initially estimated. In addition to this, activity will be supported by the part-electrification of cross-country routes, including the Great Western Main Line between London and Cardiff and the Midland Main Line between London and Kettering. According to the Office of Rail and Road (ORR), the length of electrified route increased by 43km over the course of 2016/17 to reach 5,374km, due to the completion of electrification work on the Great Western route between Reading and Didcot and also electrification works as part of the Crossrail project. However, plans to electrify three routes across the UK: the Great Western line between Cardiff and Swansea, the Midland Mainline north of Kettering and the Oxenholme to Windermere link in the Lake District were all cancelled by the government in July 2017 and, as a result, further delays or cancellations on existing schemes cannot be ruled out. Main civil engineering HS2 works on set to begin in 2019 Looking at 2019, output growth is projected to accelerate to 20.0%, reflecting main civil engineering works starting on Phase 1 of HS2. Recent data indicated that in 2017 Q3, new orders increased 974.7% in annual terms to 5.8 billion, reflecting the award of seven contracts for the project. Furthermore, in October 2017, the government announced that 300 million will be invested to ensure HS2 infrastructure can connect with the future Northern Powerhouse and Midland rail services. In the same month, the government also announced funding of 47.9 billion for CP6 ( ), 9.6 billion higher than the 38.3 billion allocated for the current control period, CP5 ( ), which will support activity in the medium to long-term. Downside risks: Main works on HS2 delayed further Work stalls under CP5 as the programme comes to an end 51

52 Infrastructure Output 30,000 million Constant Prices 25,000 20,000 15,000 10, % -10.6% 2.3% -3.1% 21.4% -3.2% 4.1% 6.3% 11.1% 5, e 2018f 2019p Source: ONS, Construction Products Association A main downside risk to rail growth emerges if main construction works on Phase 1 of the HS2 project are pushed back further. Moreover, higher construction costs fuelled by inflationary pressures could also exacerbate the project s budget issues, pushing the total cost of HS2 above the estimated 55.7 billion. Also, a potential hiatus between the end of CP5 and the start of CP6 could slow the delivery of major projects. In this case, rail output is forecast to increase 3.0% in 2018 and 5.0% in Upside risks: Network Rail brings forward finance ensuring delivery of projects If Network Rail brings forward capital investment from the next control period (CP6), in turn boosting activity within the current control period (CP5), this presents an upside risk to sub-sector growth. In this case, rail output is expected to increase 20.0% in both 2018 and The WORLD S LARGEST offshore wind farm, Hornsea One, is Currently Under Construction Electricity is the largest infrastructure sub-sector and will remain a key driver of overall sector growth during the forecast period. In the nearterm, activity will be supported by ongoing nuclear decommissioning, which includes Sellafield, the UK s largest nuclear site, and work around the National Grid power connections. Alongside this, activity will be supported by a pipeline of projects in the offshore wind farm sector. Construction works at the 2.6 billion Beatrice Offshore Wind Farm, located in the Outer Firth of Moray is currently underway and is expected to be commissioned by the end of Meanwhile, construction of the 660MW Walney and 353MW Galloper Wind Farm extension projects that form part of the Round 2 Offshore Wind Programme, as well as works at Rampion are all scheduled for completion this year. Although this suggests lower activity in 2018, this will be offset by the start of main construction works on major projects under the Round 3 Offshore Wind Programme, including Hornsea One, the world s largest offshore wind farm, and East Anglia ONE. As a result, subsector output is forecast to increase 7.0% in 2018 and a further 14.0% in 2019, which also assumes works starting on the 19.6 billion Hinkley Point C project. In July 2017, following a review of costs, EDF reported that the project risks being delayed by up to 15 months and, if this materialises, the total cost is expected to reach 20.3 billion. This came after a report was published by the National Audit Office in June 2017, which estimated a potential increase to 22.0 billion. Consequently, following an inquiry, the Public Accounts Committee reported in November 2017 that the value-for-money case supporting the project has weakened as alternative low-carbon technologies 52

53 have become cheaper. Reflecting this, as well as concerns over delivery and cost overruns, main works are largely expected to occur beyond the forecast period. Downside risks: Hiatus in new offshore wind development A downside risk emerges if heightened economic and political uncertainty during the Brexit negotiation period further undermines investor confidence, deterring new foreign investments into the UK. Furthermore, increased uncertainty over access to European Investment Bank (EIB) funding over the medium-term could stall decision-making on large-scale projects, especially in offshore wind. In this case, lower growth rates of 5.0% and 7.0% are anticipated in 2018 and 2019 respectively. Upside risks: Investor confidence improves leaving large-scale projects unaffected Swansea Bay Tidal Lagoon receives government go-ahead Improved investor confidence amid greater clarity regarding the future UK-EU relationship and stronger than expected economic conditions presents an upside risk to the sub-sector. This would, in turn, allow large-scale projects, including work previously paused under the Round 3 Offshore Wind Programme to get off the ground. Furthermore, if the 1.3 billion Swansea Bay Tidal Lagoon project in South Wales receives go-ahead from UK government, allowing works to commence in 2018, this would support higher growth rates throughout the forecast period. In this case, sub-sector output is expected to increase 18.0% in 2018 and 25.0% in In 2018, output in the water & sewerage subsector is forecast to increase 12.0%, driven by work on the largest project in the pipeline, the 4.2 billion Thames Tideway Tunnel. Excavation of the first launch shaft started in November and main tunnelling works are set to begin this year. The project has 700 million of backing from the EIB and following the EU referendum result, the Bank has stated that its funding commitments to the sub-sector will remain unchanged in the near-term, until a decision is reached on the UK s membership of the EIB. Besides this, activity will be supported by work under the current five-year Asset Management Plan (AMP6) running from 2015/16 to 2019/20, but water companies will mainly focus on efficiency, through maintenance of existing assets, rather than new build. In 2017 Q3, output in the sub-sector declined 32.4% year-onyear to 443 million, marking a third consecutive quarter of annual decline despite works occurring on the Thames Tideway Tunnel project. Contracts for the project were awarded in February 2015 and, as result new orders increased 426.6% in that year. Output rose 11.5% in 2015 and 65.2% in 2016 even though main tunnelling works on the project are yet to begin. This suggests that output is not accurately reflecting activity on the ground, and is likely to have been incorporated too early in the ONS data. By the end of the forecast period, water & sewerage output is expected to total 2.2 billion, compared with 2.5 billion in Downside risks: Main tunnelling works on the Thames Tideway Tunnel to start this year Thames Tideway Tunnel delayed 4.2bn A downside risk to sub-sector growth arises if work on the Thames Tideway Tunnel suffers from delays due to cost overruns, slowing activity on the ground. However, in March 2017, a report by the National Audit Office revealed that the government has provided a contingent support package, which aims to mitigate any downside risks, including providing financial support if cost overruns exceed 30% or if economic and political events make it difficult to access capital from debt capital markets. Nevertheless, water & sewerage output is expected to increase 5.0% in 2018, before remaining flat in

54 Upside risks: The focus shifts to new build under AMP6 Alongside construction activity on the Thames Tideway Tunnel, increasing focus on new build under the AMP6 will lead to stronger growth rates over the forecast period. In this case, growth of 20.0% is anticipated in both 2018 and Roads construction output is expected to remain flat in 2018, reflecting limited new work in the pipeline to replace completed projects, as well as the decline in new orders during the first three quarters of 2017, which is expected to feed through to output. This is consistent Construction on the UK s biggest road project, A14 Cambridge to Huntingdon, is underway with survey data from the Civil Engineering Contractors Association (CECA), which showed that workloads in roads have remained weak since 2015 Q3. Going forward, output is projected to return to growth and increase 3.0% in 2019 driven by a pick-up in activity under the 15.2 billion Road Investment Strategy (RIS), reflecting higher capital expenditure in the final two years of Road Period 1. In October 2017, Highways England published its updated delivery plan for 2017/18, which reported that around 60 of the 112 major schemes have either started or are committed to start between 2017/18 and the end of the first road period. However, it also revealed that sixteen schemes have been delayed, six paused for review, whilst two are expected to be delivered in Road Period 2 (2020/ /25). Overall, this suggests that the majority of work is heavily skewed towards the end of the road period and, as a result, this will need to be matched by a significant increase in skills and capacity in order to ensure delivery of these projects. In terms of activity on the ground, work is currently underway on the 1.5 billion A14 Cambridge to Huntingdon improvement scheme and the A19/A1058 Coast Road junction to relieve congestion. Meanwhile, work on both the A1 Leeming to Barton improvement scheme and 745 million Aberdeen Western Peripheral Route in Scotland are expected to reach completion in Spring 2018, and there is little new work in the near-term pipeline besides smart motorway schemes, which focus on the use of technology rather than new roads construction. According to the National Infrastructure and Construction Pipeline, work on six schemes is currently underway, including the M4 Junctions 3 to 12. Construction on eight others is set to begin during the forecast period. In Autumn Statement 2016, the government announced an additional 1.1 billion to upgrade local roads and transport through the National Productivity Investment Fund (2017/ /21) and 220 million to address pinch points. Furthermore, in October 2017, the government announced an additional 100 million for local road schemes across the North of England. 54

55 Downside risks: Further cuts to local authorities funding Focus shifts further to smart motorways Government focus on austerity in the nearterm could see funding to local authorities fall further, constraining their ability to deliver on roads projects. This, coupled with diminishing EU funding over the long-term, could see local government budgets stretched, leaving projects unfunded. Furthermore, increasing focus on smart motorways, mainly technology-based, rather than new roads construction could dampen activity in the sub-sector. In this case, output is anticipated to fall 1.0% in 2018, before remaining flat in Upside risks: Highways England brings forward finance If Highways England brings forward finance and projects from the final year of the first road period that will ensure a smoother profile of works. This would provide higher workloads in the near-term and ensure a gradual increase in funding and investment over the RIS, rather than the bulk of activity occurring in the final year of the programme. Moreover, financial incentives to local authorities mainly in the form of ring-fenced funding could provide more clarity on roads projects and, in turn, ensure delivery of them over the medium-term. In this case, growth of 5.0% is expected in 2018 and 10.0% in Prospects for the gas, air and communications sub-sector remain bright, with output forecast to increase 20.0% in 2018, from a low base, driven by works under Manchester Airport s 1.0 billion ten-year investment programme, as well as Gatwick Airport s 1.2 billion and Heathrow Airport s 3.2 billion five-year capital investment programmes that will support activity throughout the forecast period. Work under Luton Airport s 229 million investment programme is currently underway, whilst construction work under London City Airport s 480 million expansion programme and the development of a new 130 million arrivals terminal at Stansted Airport are expected to start this year. Besides this, activity will be supported by work under BT s 6.0 billion investment programme to extend its ultrafast fibre and mobile broadband network to at least 10 million premises by 2020, as well as Virgin Media s 3.0 billion Project Lightning programme, which aims to extend its fibre network to four million additional premises by According to Virgin Media s preliminary results, 147,000 new connections were added in 2017 Q3, compared to 127,000 in Q2, bringing the total to 943,000 premises since the project s inception in February Given that a final decision to build a third runaway at Heathrow Airport is now expected in 2021, following another period of examination, the project has not been factored into our projections as main works are expected to occur beyond the forecast period. Nevertheless, in 2019, sub-sector output is projected to increase 10.0% to 894 million. Downside risks: Further delays in expansion to superfast broadband A downside risk to sub-sector growth emerges if work under both Virgin Media s and BT s superfast broadband programmes faces delays. This would result in lower activity on the ground and, as a result, sub-sector output is expected to rise 7.0% in both 2018 and Upside risks: Substantial progress is made in expanding broadband across the UK New gas storage investment occurs If progress is made on expanding broadband across the UK, including work under both Virgin Media s 3.0 billion and BT s 6.0 investment programme, this presents an upside risk to subsector growth. This, as well as new investment in gas storage in response to utilising shale gas reserves and given the closure of Rough, which accounts for 70% of the UK s total storage capacity, would underpin stronger growth rates of 25.0% in 2018 and 15.0% in

56 Infrastructure R&M Infrastructure repair and maintenance (r&m) includes work on assets owned by utility companies, publicly-funded assets such as roads and rail, airports and energy-generating facilities. Estimated cost to clear local roads maintenance backlog: England 10.8bn (13 years) Wales 591.5m (9 years) London 686.1m (10 years) (Source: AIA 2017 ALARM survey) Highways England has a maintenance budget of 1.3 billion over its first fixed five-year investment period, which began in 2015/16. In 2018/19, expenditure on maintenance is set to rise to 268 million from the 256 million allocated for 2017/18, before falling to 265 million in the final year of the first road period. However, local authorities manage 97% of the roads network and remain financially constrained. According to the Local Government Association, local authorities will face an overall funding gap of 5.8 billion by As a result, basic repairs and maintenance are unlikely to be a key driver of work in the sector despite the urgent need for basic repairs to roads. In 2016, the government allocated 70 million of funding from the 250 million Pothole Action Fund for use by local highway authorities across England in 2017/18 that will help repair 1.3 million potholes. Furthermore, in Autumn Budget 2017, the government announced that an additional 45 million will be invested in the Pothole Fund in 2017/18 to tackle around 900,000 potholes across England. However, the Asphalt Industry Alliance s 2017 ALARM survey reported that there was a 13- year backlog of local roads maintenance in England, at a value of 10.8 billion. For London, the average maintenance backlog was 10 years ( million). In the rail-sub-sector, r&m output is likely to be overshadowed by new build activity under CP5. According to the ORR s Network Rail Monitor published in December, Network Rail s spending on maintenance is forecast to reach 1.4 billion in 2017/18, 15 million higher than its initial budget. Furthermore rising cost pressures and a backlog 56

57 Infrastructure R&M Output million Constant Prices 10,000 8,000 6,000 4,000 2, % 8.1% 3.6% 2.0% 0.0% 0.0% -3.5% -2.1% -6.2% e 2018f 2019p Source: ONS, Construction Products Association of work under the current control period are likely to increase financial pressure on CP6 ( ). Overall, infrastructure r&m is forecast to remain flat in both 2018 and Downside risks: Local authorities subject to further budget cuts R&m output is likely to be overshadowed by new build activity rather than basic maintenance Further cuts to local authority funding amid constrained spending by central government under any further austerity programme pose a downside risk to sub-sector activity. In the event of this, local authorities may be forced to finance new build from maintenance budgets in order to ensure delivery. In addition, increased pressure on government departmental budgets could lead to schemes being cancelled or delayed. Against this backdrop, r&m output is expected to contract 3.0% in both 2018 and Upside risks: Central government increases infrastructure r&m spending quickly A large increase in ring-fenced funding to local authorities for transport projects that allows work to get off the ground, in turn, providing a boost to both infrastructure r&m output and the wider economy presents an upside risk. In this case, output is anticipated to increase 2.0% in 2018 and

58 The Construction Products Association represents the UK s manufacturers and distributors of construction products and materials. The sector directly provides jobs for 300,000 people across 22,000 companies, and has an annual turnover of more than 55 billion. We act as the leading voice to promote and campaign for this vital UK industry. The CPA produces a range of economic reports including quarterly Construction Industry Forecasts, Construction Trade Surveys, State of Trade Surveys and various bespoke research. These publications are available free to members and via subscription to non-members. To learn more, please contact our Economics team at or visit 58

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60 ISBN: February 2018 Construction Products Association 26 Store Street London WC1E 7BT Tel: