Inflation and construction contracts

The Bank of England announced at the beginning of February that CPI inflation is expected to hit 7.25% in April, which is at a level not seen for decades. Whilst this is not wholly representative of inflationary pressures on a construction project, it does highlight an underlying trend that prices of materials/goods and labour in general are rising. 

However, it could underestimate the increase in costs of certain materials in the construction industry. By way of recent examples, over the course of 2021, the price of fabricated structural steel increased by 59% alone and concrete reinforcing steel bars also increased 51%. [Source: Department for business, energy and industrial strategy's (BEIS) 'Monthly statistics of building materials and components' - January 2022]

So contractors and developers, understandably, are reviewing their options regarding pricing for projects in the immediate future. These include the:

• Type of building contract to be used (whether it be lump sum, target cost, reimbursement, re-measurement, etc.);
• Advance purchase of materials (if there is a concern that the cost of certain materials are to increase further still);
• Allowance for the price of inflation in building contracts (e.g. the use of Fluctuations Options in a JCT design and build contract or the inclusion of Option X1 in an NEC engineering and construction contract); and
• Use of provisional sums for the purchase of certain materials (assuming that the building contract provides for such sums).

Factors to take into consideration when reviewing the various options include:

1. contract length - a longer contract period increases the risk of cost increases regarding materials and labour; 
2. familiarity with fluctuation mechanisms and their application - whilst parties may have the best of intentions in agreeing to include an inflationary mechanism in a building contract, if the parties do not understand how to operate the mechanism then the risk of a dispute occurring between the parties increases; 
3. cost of additional measures (e.g. storage and security of materials purchased in advance,  additional management costs where reimbursement contracts are used, etc.); and
4. contract sum - the lower the contract sum then the appetite to negotiate and agree measures to address inflation concerns may be reduced.

Twelve-month CPI inflation rose from 5.1% in November to 5.4% in December, almost 1 percentage point higher than expected at the time of the November Report. Inflation is expected to increase further in coming months, to close to 6% in February and March, before peaking at around 7¼% in April. This projected peak is around 2 percentage points higher than expected in the November Report.

https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2022/february-2022