Construction activity returned to growth in July – EY ITEM Club comments

• The construction Purchasing Managers’ Index (PMI) rose to a five-month high in July, avoiding the falls seen in the same month’s services and manufacturing indices. Robust growth in commercial building contributed towards pushing the PMI back into expansionary territory. But a rise in the headline PMI disguised continued weakness in house building, which the latest rise in interest rates won’t help.
• Construction is benefiting from a return to normality in supply chains and resilience in the wider economy. Cost pressures are also continuing to recede. But high interest rates present a significant counter to these positives, particularly given the sector’s interest-sensitivity. That said, the possibility that August’s interest rate rise may prove to be the last, or near-last, in the current cycle means the challenges from higher borrowing costs may at least be limited.  

Martin Beck, Chief Economic Advisor to the EY ITEM Club, says: “The construction PMI rose to 51.7 in July from 48.9 in June, avoiding the falls seen in the same month’s services and manufacturing indices. The latest construction reading was the highest since February.

“However, an overall rise in activity disguised a continued divergence between residential and commercial construction. The former declined for the eight consecutive month, although the rate of decline was the least marked since April. But civil engineering and commercial building both expanded at a solid pace, lifted by rising demand for refurbishment projects and greater opportunity for infrastructure work.  

“A return to growth in overall construction activity was probably aided by further evidence of healing supply chains. Supplier lead times shortened to the greatest extent for nearly fourteen-and-a-half years and while input costs rose modestly, the rate of increase was much lower than that averaged in the first half of 2023.

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

“However, high interest rates present a significant counter to these positives. Following August’s rise, the Bank of England policy rate now stands at a 15-year high of 5.25%. Rising borrowing costs will reduce the commercial viability of construction projects and present a particular headwind to housebuilding and the housing market in general. That said, the EY ITEM Club thinks this headwind is unlikely to get much stronger. Increasingly favourable moves in leading indicators of inflation, including the latest evidence of declining cost pressures offered by the PMIs, mean the EY ITEM Club thinks the current rate rise cycle is now close to peaking, or potentially already has.”