Weak construction PMI disguises divergence within the sector – EY ITEM Club comments

• The latest construction Purchasing Managers’ Index (PMI) fell into contractionary territory in June for the first time in five months. However, commercial building continued to grow, with the headline index pulled down by residential activity. There was better news on inflation with input prices falling for the first time since January 2010. 
• Construction is benefiting from normalisation of supply chains and should gain from a gradual increase in momentum in the wider economy. But rising interest rates, and the prospect of more rate rises to come, will hold back economic growth and present a particular headwind to a housing market, and housebuilders, already under pressure.   

Martin Beck, Chief Economic Advisor to the EY ITEM Club, says: “June's construction PMI signalled a sector in contraction. The index fell to 48.9 from 51.6 in May, the first reading below the S&P Global/CIPS survey's 50-'no-change' mark in five months. Based on past form, the latest PMI is consistent with near-stagnant rental value growth over the rest of this year. 

“However, an overall fall in activity disguised a divergence between residential and commercial construction. The former declined at the fastest rate since April 2009, excluding the pandemic period. But civil engineering and commercial building both expanded at a solid pace, with the latter lifted by rising demand for refurbishment projects.   

“Weaker overall activity was accompanied by inflationary pressures easing further. The price of inputs paid by construction firms fell for the first time since January 2010 and lead times among vendors in June shortened to the greatest extent in around 14 years. 

“Construction activity should gain from the increase in economic momentum the EY ITEM Club expects over coming quarters. And the introduction in April of 100% expensing for plant and machinery investment could support commercial building projects. 

“However, rising interest rates present a significant counter to these positives. The Bank of England’s policy rate now stands at a 15-year high of 5%. The EY ITEM Club thinks sticky inflation and strong pay growth mean the Bank of England will increase rates further. And the prospect of a prolonged period of above-target inflation and a tight labour market will delay the point at which rates are cut. This will slow construction and development, and presents a particular headwind to housebuilding and the housing market in general.”