Economic outlook: what do bond market developments mean for construction?

The financial markets didn’t deliver the cheeriest of New Year messages to Chancellor Rachel Reeves. The UK 10-year gilt yield peaked at 4.89% in mid-January, the highest rate since the 2008 financial crisis, while the 30-year gilt yield was trading at its highest level since the late 1990s.

BCIS’s Chief Economist Dr David Crosthwaite explains what the figures mean and what the implications for construction might be in the coming year.

Gilts are bonds issued by the government, so buying a gilt essentially means you are lending money to the government in return for regular interest payments and your money back at the end of the term. When the yield – the interest rate – goes up, it means the price of the gilt has gone down and the government has to offer higher returns to attract buyers.

Rising gilt yields therefore means borrowing is more expensive for the government, and can result in curtailed spending plans, higher taxes, or potentially both. For Rachel Reeves, rising yields eats into the little headroom she has in her self-imposed fiscal rules.

While comparisons to Liz Truss and Kwasi Kwarteng’s disastrous mini budget were banded about for a couple of days, the yields have since eased. Defending her position in the Commons in the aftermath, amid calls for her resignation, Chancellor Rachel Reeves claimed the market turmoil was a result of ‘global economic uncertainty’. She said of her economic plans, ‘If we get it right, the prize on offer to the British public is immense.’

From what we have seen so far, that’s a pretty big ‘if’.

The latest output figures for construction showed a 0.4% increase in November compared with the previous month, with increases in both new work and repair and maintenance. There’s every chance this will be revised downwards next month by ONS, but otherwise it’s fairly positive news, especially when compared to wider economic performance.

GDP, however, a key indicator of the country’s economic growth, or otherwise, was up by just 0.1% in November, which again could be revised by ONS. Compared with the three months to August 2024, GDP is estimated to have exhibited no growth in the three months to November 2024. Essentially, the economy is flatlining or, at best, bumping along the bottom.

The gilt yield increases are something of a delayed reaction to the Autumn Budget, the response presumably coming once a thorough assessment of all the implications had taken place. There’s also ongoing uncertainty, for the UK and globally, surrounding the second Trump presidency.

All of this serves to pile more pressure on the Bank of England (BoE) to cut the base rate when its Monetary Policy Committee meets next week, in order to help stimulate the economy. While I suspect we’re heading back into recession, I expect it will be short-lived because the BoE will try to introduce some stimulus having seen such poor growth levels and a fall in confidence.

What does all of this mean for construction and should the industry be concerned?

I do believe this is a temporary blip, but there is definite cause for concern. The market’s response over recent weeks shows a distinct lack of confidence in the UK economy, our debt levels, and the policies being pursued by the government. And we haven’t yet got to April, when the inflationary effects of increases to employers National Insurance contributions and the National Living Wage will kick in.

While financing costs remain high, and investment therefore less viable, we’re likely to see limited growth in both industrial and commercial sectors. Likewise, the state of public finances is going to put a lot of pressure on public sector schemes.

Residential also continues to show limited output and, in sentiment surveys like the S&P Global PMI for UK construction, housing activity has lagged behind commercial and civil engineering for the last couple of years.

New orders data, which will be published mid-February covering the final quarter of 2024, will hopefully give us a spark of optimism that wasn’t in the latest dataset. Total new orders in construction fell by 22% in the third quarter of last year, close to a reduction of £10 billion compared with the second quarter. Within this, public new housing saw a 41% decrease and private housing was down by 31%.

While there was a post-pandemic uptick in repair and maintenance output, often keeping overall construction output in positive territory while new work dipped, it’s turned a corner over the last quarter and started to decline. This is a consequence of cost-of-living pressures as well as the tightening public purse, both of which are likely to persist in the near-term.

As well as casting further doubt on the government’s house building targets, the current economic backdrop all points to a relatively unfavourable investment climate, which is going to continue to impact some sub-sectors negatively.

All of the recent turmoil will hopefully, at least, impress upon Reeves the importance of delivering the second phase of its Spending Review as soon as possible. It has already been delayed from a vague commitment of spring to ‘late spring’, now expected to be around June, unless it is brought forward. It is crucial for our sector to get a better idea of what spending plans are going to look like going forward.

In the meantime, we’re in a position where the economy is performing slightly worse than expectations, but inflation is slightly better than expectations. Positive action from the Bank of England to boost growth is going to be instrumental in how construction fares over the coming year.

As is the government. With Reeves hinting at support for a third runway at Heathrow, possibly to be announced in a speech this week about boosting growth through cutting planning red tape and accelerating building projects, we might finally get some tangible and much-needed detail from them about how they are going to do it.

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