Three ways construction industry could be boosted by reduction in the base rate

Overall increased construction activity was reported for the second month running in the latest update to the S&P Global UK Construction Purchasing Managers’ Index. The index, which tracks changes in the volume of business activity through a monthly survey of around 150 construction firms, was at 53.0 in April, up from 50.2 in March, the strongest pace of growth since February 2023. This, coupled with falling inflation, indicates there are signs construction output could be on the up.

However, the cost of borrowing remains relatively high when compared to the recent past – last week the Bank of England’s Monetary Policy Committee (MPC) voted to keep the base rate at 5.25% for the sixth consecutive time. The general assumption is that it will be decreased to 5% at the end of next month.

But, as the crisis continues to unfold in the Middle East, the industry finds itself grappling with yet more uncertainty, characterised by persistent low growth. If the MPC waits until the summer to reduce the base rate, it could be too late to turn around an ailing situation.

Here are three reasons from our Chief Economist, Dr David Crosthwaite, why cutting the base rate sooner rather than later could help get construction and the wider economy growing.

It could reduce the cost of borrowing to boost investment in new construction

New construction work is essentially driven by investment which, in turn, is impacted by the cost of borrowing. If investors in built assets can see a potential return on their investment, then they will bring schemes to fruition. If, however, there is no return evident due to high borrowing costs, then the investment will not go ahead or will be stalled until a more favourable investment climate appears, i.e. the cost of borrowing reduces. This is important for attracting domestic investors but also ensuring we can compete with international investors on a global scale.

It could kick-start private housing output

The housing market is fundamentally impacted by the cost of borrowing as it feeds through to mortgage rates. Affordability issues have become a major issue in housing, impacting both the demand for housing and, in turn, the supply. Most new housing is provided by property developers, who are essentially speculators and control supply based on the potential returns they will realise from a sale.  Given that current demand is subdued, due to affordability issues, they have responded by reducing the numbers of properties that they build and bring to market. This position will likely improve once the base rate falls and demand recovers.

It could increase investment in home improvements that would improve their energy efficiency

While repair and maintenance showed strong growth throughout 2023 – with output up 8.3% on the year – it’s forecast to fall across all sectors in 2024 by 5.6%, compared with last year, according to our latest quarterly forecast. While high mortgage rates have encouraged residential property owners to invest in repair and maintenance, rather than move, their budget continues to be constrained by the high cost of borrowing required to do this.

Aside from home improvements, reducing the base rate could also enable homeowners to invest in insulation and/or innovative technology that could improve the energy efficiency of their homes. This would, in turn, support the green collar economy and the government’s net zero targets.