United Kingdom Infrastructure Report Q1 2009

We have revised down our construction sector forecasts a little further this quarter. We now expect the construction sector to contract by 1.5% in real terms in 2009, compared to a previous forecast that it would expand by 1.6%. The UK's strong links to the US economy and its over-dependence on the financial services industry as an engine of growth make it particularly vulnerable to the economic fallout from the turmoil in America. We predict a considerable contraction in US real GDP growth in 2009, which will feed through to negative growth in the UK economy for the year too. In this context, the commercial and residential real estate markets in the UK are likely to remain under pressure. Although the Bank of England has cut interest rates aggressively over the last quarter, the damage sustained by banks' balance sheets indicate that lending to the private sector (including construction companies) is likely to remain depressed, despite the efforts of the government to exert pressure on banks to lend more.

Projects across a range of infrastructure sectors have had to be shelved over the last quarter, because of companies' inability to secure funding and/or concerns about the lack of demand from potential end-users.

However, after the predicted contraction in 2009, we forecast that the UK's construction sector will undergo positive real growth in 2010, in the order of 1.5%. This is based on our Country Risk team's prediction that the economy as a whole will return to positive growth, on the back of an expansionary fiscal policy by the government. Notwithstanding the problems of regional authorities, higher spending by the London-based British government should boost public sector investment in infrastructure across the UK as a whole, helping the construction sector (and the wider economy) to revive.

Risks to our forecasts are largely to the downside, particularly for 2010. Much depends on how prolonged the recession is in the UK. Although our core scenario envisages that 2010 will witness a recovery, this is by no means a foregone conclusion. An extended recession would likely mean a continuation of negative growth in the construction sector in 2010, and possibly beyond. A key risk is that the British government could be forced to retrench in the event of an extended recession, due to concerns about debt sustainability. In this worst case scenario, instead of being a supportive factor, the public sector as a whole would become a drag on overall construction activity before the private sector had recovered.

In November, Portland Gas was forced to put a GBP500mn gas storage project in Dorset on hold due to a lack of funding. The difficulties have not been confined to private sector operators, with the semiautonomous Scottish government forced to scale back investment in a new road bridge by GBP1.6bn- GBP2.1bn.