Research Briefing | Mar 16, 2023

Implication of inflation pressures and monetary policy normalisation on construction markets

Cost and availability of financing are critical to the health of construction markets. With interest rates at historically low levels across the developed world for most of the past decade and inflation remaining comfortably benign, policy makers and businesses alike may have forgotten the importance of this fundamental relationship. Depending on the trajectory of inflation and monetary tightening, they may be in for a rude awakening.

What you will learn:

  • Clearly many factors, ranging from demographics to broader economic growth to government spending priorities, have large impacts on construction activity. But one dependable pattern that is visible in the data despite these crosscurrents is that large changes in interest rates signal eventual turning points in construction activity.
  • The US over the past two decades provides ample evidence. The defining characteristic was a construction downcycle that began at the onset of the 2008-09 financial crisis. While lax mortgage lending standards epitomised by the subprime mortgage market were clearly a major trigger by inflating housing demand, the sharp rise in the Federal funds rate from 1% to 5% several years prior had an important contributing role, with construction spending turning downward in early 2006, two years after the beginning of monetary tightening and well before the broader problems in financial markets.
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