The potential for recession due to the energy and cost-of-living crises triggered by the Russian war in Ukraine is turning out to be milder than feared. However, the resumption of economic growth will remain restrained in 2023. Leading indicators such as the Purchasing Managers’ Index (PMI) and the ifo Business Climate Index have been rebounding since November, encouraged by above-average gas storage levels and the completion of three floating liquefied natural gas terminals by January 2023. This has erased concerns of possible gas rationing in German industry, contributing to a downward correction of prices. Yet, higher energy security has come at a cost, and gas and electricity prices will likely never return to pre- 2021 levels.
The associated boost to inflation has forced the European Central Bank (ECB) into aggressive monetary tightening while damaging consumers’ real purchasing power and firms’ profitability. This will likely still ensure that the German economy contracts slightly during the two quarters saddling the turn of 2022/23, followed by an only cautious recovery during the remainder of 2023. Fixed investment declined in Q2 2022, driven exclusively by construction. In contrast, investment in equipment expanded throughout 2022, despite war-related uncertainty and the ECB’s monetary tightening.
Demand for construction remains
Looking beyond 2023, demand for construction will remain supported by factors such as pent-up housing demand, migrant needs, and public spending on transport, energy, IT infrastructure, and the military.
Latest PMI data from S&P Global showed the rate of decline in construction activity eased in February. A lack of incoming new work was cited, although the rate of contraction eased, and businesses were less pessimistic about the year-ahead. Cost pressures across the sector continued to soften from the levels seen over the past two years, amid reports of easing supply-chain constraints.
The headline S&P Global Germany Construction PMI remained in contraction in February but climbed from January’s 43.3 to 48.6. A rise in civil engineering activity, the first for almost a year, was recorded in February, alongside a slower decline in housing activity. New orders decreased, as businesses commented on the influence of soaring prices for construction, tightening financial conditions and general consumer hesitancy due to the uncertain economic outlook.
The decline in new orders did at least slow for a third straight month to signal the softest rate of contraction since March last year. Building companies maintained a negative outlook for the year ahead, with far more firms expecting a decrease in activity (36%) than those anticipating a rise (10%). Lower activity led constructors to further reduce their buying levels. The fall in demand for building products and materials in turn helped to ease pressure on supply chains.
The easing of supply-demand imbalances was underscored by a cooling of the rate of purchase price inflation. Input costs showed the slowest increase since November 2020, with the rate of inflation falling below its long-run average since 1999. Lastly, February’s survey showed a reduction in construction sector personnel.
Real total construction spending in Germany declined by 1.5% in 2022 and is forecast to fall 2.6% in 2023, as economic uncertainty, persistent inflationary pressures, and tighter financial conditions depress demand. Residential construction declined by 2.1% in 2022 and is forecast to fall 4.0% in 2023 and 1.0% in 2024, even as an influx of Ukrainian refugees and other migrants is increasing demand.
The problem is high mortgage rates and consumer inflation, as well as the sharp rise in construction costs. According to Destatis, the construction price index for residential buildings rose 16.9% year on year (y/y) in Q4, 2022, marking the sixth successive quarter of double-digit annual growth. The number of building permits for dwellings issued from January to November 2022 fell 5.7% compared with the same period a year earlier, while housing new orders fell 14.9% over the same period.
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In non-residential structures, we also expect a downward trend in 2023, falling by 2.6%, after a decline of 1.4% in 2022. That said, demand for ultramodern and environmental, social, and corporate governance (ESG) compliant space is expected to remain strong. After rising by 0.4% in 2022, infrastructure construction spending growth should pick up to 2.4% in 2023 and 2.8% in 2024 due to public investment in transport and energy projects. Infrastructure projects will benefit from the EU Recovery and Resilience Facility.
Construction spending will experience a 0.3% compound annual growth rate between 2021 and 2026, with growth led by the infrastructure segment. In the longer run, growth will improve to a 1.2% compound annual rate between 2026 and 2031. The infrastructure segment will again demonstrate the highest growth over the period. Manufacturing construction has held up relatively well this decade, however, there are indications of slowing as the German economy transforms its energy usage, reshoring limits exports to some countries and a slowing global economy reduces demand to others. Overall, manufacturing will become less important to the construction economy as the rate of growth recedes. Utilities suffer as Germany struggles toward a net zero economy. As energy independence is achieved, refining becomes less important. Transportation equipment investment has a strong near term, but may tail off as plants complete transition to EVs with fewer parts. Electrical and electronics industries will pick up some of that slack. iC