Macro Moments Weekly: Building a future

As we near mid-winter, bleakness has already crept into the construction sector. Combined supply-side and demand-side constraints cloud the outlook. The UK economy has just become the woeful winner, edging out Germany, but the rest of Europe feels the moan of stormy winds, too.

Economy

After a week of solid economic data from Europe, one area of weakness is visible and pervasive: construction. The four major economies in Europe are showing steep declines, led by residential and commercial building, with some glimmers of hope in civil construction, particularly in Germany.

Why? The rise in interest rates would be the easy answer for declines in building, and it’s true: Higher rates price out house buyers and investors alike. But rising rates should be no deterrent when confidence levels are also rising. In the old days, rising rates were a sign of confidence, not weakness, a sign the banks were lending and companies were investing.

In reality, a loss of business and consumer confidence is driving the decline. In Germany and the United Kingdom, government-funded civil engineering plans are gearing up but not enough to offset declines.

In such a negative environment, why are companies complaining of rising costs? Wages are still not retreating, but the real mystery is materials—with so much spare capacity, why aren’t they falling in price? Here we have to take a lesson from the retail sector. During the global financial crisis in 2008, the retail sector figured out that it’s better to restrict supply and hold prices steady than chase non-existent demand. Is this cartel pricing? Or oligopolies at work? Maybe, but building products are heavy and expensive to move, so they don’t travel, meaning that it’s always a local market. Perhaps we see the effects of a series of mini-monopolies, created by decades of regional mergers and consolidation.

I believe it will only be when demand kicks in, when the brick kilns and the aggregates orders start to rise and fill capacity, that any price flexibility may emerge. But don’t hold your breath for it!

And of course, this European situation is in stark contrast to the United States, where although there is a new-build housing slump, it is merely a rounding error relative to the data-centre building boom.

But housing is vital to the United Kingdom. Recent budget forecasts for growth depend upon it, and with the multiplier effect, so does the longevity of growth. This year is another one marked by falling real house prices and thus improving affordability. UK house prices adjusted for inflation have been falling since 2008, and in London since 2016. Remarkably, this has happened while the population has risen by five million—about 8%—over the same period.¹ Material costs are rising faster than inflation and wages are more than keeping up, which combined, squeeze builders' margins. However much planning laws are freed up, lower interest rates are needed to improve affordability. We also need rising real incomes, which as a result of the latest budget, might only grow 0.7% per year due to rising taxes.²

Ultimately, this means the rental sector will likely benefit—more people for fewer houses means higher prices, and that has a significant impact on inflation numbers. Where could this leave interest rates as the push-and-pull factors even themselves out?

Parting shot

The Spanish parliament failed to pass a new budget, once again, which requires rolling over the 2023 budget for another year. Since 2023, Spain has grown 9% in total, faster than almost any other EU country, and stands in especially strong contrast to Germany, which has contracted over the same period.³

Less (politics) is more.