Key points:
* Housing market downturn still severely affecting construction sector.
* Civil engineering best-performing sub-sector, showing only slight contraction.
* Fuel and raw material shortages still exerting substantial pressure on input prices.

Summary:
Operating conditions in the UK construction economy continued to deteriorate in August. The weakening health of the sector reflected declines in activity levels, new orders, employment and purchases, as the industry continued to suffer the combined effects of the credit crisis, widespread input price inflation and the wider global economic downturn.

The headline figure from the report, the seasonally adjusted CIPS/Markit UK Construction Purchasing Managers' Index® (PMI®) – an indicator designed to provide a single figure measure of the trends in construction sector output – registered 40.5 in August. The reading was up from July's survey low of 36.7 but remained firmly below the neutral mark of 50.0, indicating a further sharp fall in total industry activity.

Activity levels fell across all three sub-sectors of the UK construction economy in August, albeit at slower rates than in July. Of the three, by far the most striking was the rapid contraction in housing construction. Although slightly higher than its record low of 18.7 in July, the seasonally adjusted Housing Activity Index came in at 27.2 – a reading considerably lower than both the annual and long run averages. In contrast, civil engineering performed the best, posting only a modest decline in business activity.

Lower overall activity levels were attributed by the majority of respondents to poor demand conditions creating fewer opportunities to tender.

With supply outstripping demand for construction work, competition to win new orders was high, driving down the values of tenders and making it difficult to secure contracts. Average incoming new work to UK constructors therefore fell at a substantial pace, albeit one slower than the previous month.

With new orders and activity levels falling, there was little appetite to invest in either raw materials or workers. Purchasing activity, staffing levels and sub-contractor usage were therefore reduced further – although at weaker rates than in July. The seasonally adjusted Quantity of Purchases Index came in at 44.5, while the drop in sub-contractor usage was reflected by the seasonally adjusted Sub-Contractor Usage Index, which posted a reading of 43.4. As demand for raw materials softened, average vendor performance improved solidly. Lead times have now shortened for the past four months.

Business sentiment remained subdued in August as many constructors expected the economic downturn to continue. That said, after reducing during each of the previous five months, the degree of confidence in the sector held steady at July's series low as the Future Business Activity Index came in with a reading of 51.2 again.

Adding to the overall gloomy picture, input price inflation, although slower than in July, persisted at a high level with the seasonally adjusted Input Prices Index posting a reading of 78.5. Increased raw material and fuel costs were blamed for the latest inflation. Sub-contractors also raised their charges slightly, despite falling demand for their services and their increased availability.

Comment:
Commenting on the UK Construction PMI® survey, Roy Ayliffe, Director of Professional Practice at the Chartered Institute of Purchasing and Supply, said: “UK constructors are still feeling the bite of the credit crunch. Although the latest data suggest that the rate of contraction in the sector is easing, conditions remain relatively depressed overall. With far fewer new business opportunities to pitch for, purchasing managers said competition between firms intensified which in turn lowered the values of tenders.

“Housing was again the Achilles Heel of the construction sector, as August data signalled nine consecutive months of housebuilding decline. In an attempt to cope with the onslaught of rising prices, difficult trading conditions and narrowing confidence, purchasing managers were forced to further reduce levels of procurement activity, while more jobs were axed.”

Gemma Wallace, Economist at Markit Economics, said: “Weaknesses, manifested as the credit crunch and global economic downturn took hold over the past year, were still evident throughout the UK construction economy in August. The stagflationary combination of lower activity and new order levels plus persistently high inflation was again recorded across all construction sub-sectors. This was particularly noticeable in the housing industry where activity fell at by far the fastest rate. Consequently, confidence regarding the coming twelve months remained subdued.

“However, it was not all bad news. Total industry activity, new orders, employment, sub-contractor usage and purchases all contracted at slower rates than in July, while input price inflation eased further. There was also evidence that the civil engineering sub-sector may be on the brink of a recovery. These are all steps in the right direction, although it is unlikely that conditions within the sector will improve in the near future.”

The September Report on Construction will be published on Thursday 2nd October 2008