Managing cost volatility in UK construction projects

Readers may recall our article of 27 April 2026 which addressed the macroeconomic effects of the Iran War on the UK construction industry, with a particular focus on material price volatility and supply chain disruption.  

We highlighted that rising input costs have placed significant pressure on both contractors’ margins and project viability. In this article, we explore this notion in further detail and consider mechanisms available to hedge against inflationary risks in the construction industry. 

The current landscape 

The construction industry remains a cornerstone of the UK economy, generating a turnover of approximately £368.3 billion in 2024. The sector is not only significant in its own right but also plays a vital role in the wider UK economy, supporting numerous industries that rely on construction activity for their operation and growth.

In recent years the sector has faced sustained cost pressures driven by persistent increases in both energy and material prices. More recently, geopolitical instability in the Middle East has exacerbated these challenges, increasing uncertainty, placing further strain on global supply chains and contributing to a prolonged period of elevated interest rates.

The cumulative effect has been a marked increase in project costs, erosion of contractor margins and ongoing disruption to procurement and delivery programmes. These inflationary pressures have fundamentally reshaped the commercial and legal landscape of construction projects, placing heightened importance on risk allocation, pricing mechanisms and contractual resilience.

Looking ahead 

In the first quarter of 2026  the RICS workload indicator (UK) fell to a net balance of -12%, indicating a reduction in construction momentum as global uncertainty continues to impact development activity. During the same period, the BCIS reported a steady increase in material prices across all work categories.  

The BCIS emphasise that material price movements are often uneven both in scale and timing. For instance, over the 12 months to March 2026, the average price of aggregates increased by 8.4%, compared to a decrease of 7.1% for concrete reinforcement. 

Looking ahead, BCIS forecasts tender inflation at 3.5% for 2026, 2.4% in 2027, 3.3% in 2028 and 2.9% in 2029. By contrast, Stace adopts a more cautious position, forecasting average annual inflation of approximately 3.5% over the same period. These forecasts underscore the difficulty of predicting costs in the current climate. In these conditions, both contractors and employers should closely monitor market developments and ensure that appropriate contingencies and risk allowances are built into project pricing and contractual arrangements.

Set out below are key considerations when working on existing projects. 

Existing projects 

Negotiation 

During periods of market volatility, the UK Government and industry bodies alike have published best practice guidance promoting fair and reasonable conduct, encouraging parties to work in a spirit of mutual trust and co-operation. Notable examples include the Government’s Guidance on Responsible Contractual Behaviour and the Construction Leadership Council’s call for ‘collaborative discussions’ during Covid-19 pandemic.

Commercial and financial pressures affecting one party will often have wider implications for the project. In periods of exceptional economic uncertainty, parties should engage constructively and consider pragmatic commercial solutions wherever possible. Contractor insolvency can have consequences extending far beyond the immediate contractual relationship. An employer required to reprocure the remaining works is likely to incur additional costs and face increased risk premiums, while any replacement contractor may be reluctant to assume responsibility for work carried out by its predecessor. In such circumstances, a negotiated commercial resolution may represent the most effective and commercially sensible outcome.

Contract terms 

Parties should review the pricing mechanism to determine whether the contract is fixed price or allows for price fluctuations – i.e. that allow for pricing adjustments to be made to reflect changes in market conditions. 

In the absence of a fluctuation mechanism, the contract is likely to operate on a lump-sum basis, with only limited opportunities to adjust the contract sum through variations or loss and expense claims. In these circumstances, parties should consider a proactive and collaborative approach to manage price increases. This does not necessarily require a direct adjustment to the contract sum and alternative approaches may include reducing or waiving liquidated damages, lowering retention levels (which with consideration to the Commercial Payments Bill may be a timely discussion), or making advance payments for long‑lead materials to help alleviate cashflow pressures and reduce exposure to further price increases.

Future projects 

When tendering for new projects, parties should consider how price fluctuations are allocated and managed. Certain fluctuation provisions are often better suited to specific projects, so consideration should be given to the scope, complexity, duration and risk profile of the project.

Set out below are several key considerations for parties when assessing the suitability of a fluctuation provision:  

Risk allocation: 

Risks should be allocated to the party best placed to manage, control and effectively mitigate against them. This approach promotes efficient risk management, reduces the need for contractors to price in unnecessary risk premiums, and supports better project outcomes by minimising the likelihood of unforeseen cost increases. 

Fluctuation provisions 

As discussed above, fluctuation provisions are intended to manage inflationary risk. Employers seeking greater cost certainty often seek to exclude these provisions. In response, contractors are likely to price the risk resulting in higher tender returns, increased value engineering and, in more extreme cases where the risk has not been adequately allowed for, contractor insolvency. 

There are several mechanisms available to contracting parties that facilitate fluid pricing over the life of a project allowing the allocation and management of cost risk to adapt to evolving market conditions.

1. Labour and materials cost movements 

Where market prices for labour, materials, electricity or fuels increase or decrease after the base date, the cost movement can be valued and reflected through adjustments to the contractor’s payment applications. 

2. Index‑based formula adjustments 

The contract sum may be adjusted by reference to recognised indices. The BCIS states that:

“Choosing the right index is essential to ensure adjustments, benchmarking and contract mechanisms reflect what is actually happening in the market.” 

Despite this, construction projects frequently rely on the Consumer Price Index (CPI) or the Retail Price Index (RPI) to rebase price movements. This is questionable considering food and beverage items such as croissants, alcohol-free beer and houmous are amongst the most recent additions to the 2026 basket of goods used to calculate CPI. 

To emphasise this risk, in the 12 months to March 2026, the BCIS reported an average increase in the price for structural steel of 8.2%. Comparatively, CPI in the 12 months to March 2026 was 3.3%. Projects with a sizeable portion of structural steelwork and with indexation provisions linked to CPI, could theoretically see a shortfall of c.4.9%. Whilst we acknowledge that this is, in practice, an over‑simplification, it nevertheless serves to demonstrate the potential shortcomings on relying on a generic index to measure and calculate construction related cost fluctuations.

3. Bespoke mechanisms and caps 

Parties may also agree bespoke mechanisms to address price increases. These may include shared-risk arrangements, under which the contractor absorbs a defined proportion of any increase and the remaining cost is shared between the parties. In addition, a cap may be applied to limit adjustments to an agreed annual amount or an overall cumulative threshold, thereby balancing inflation risk with the employer’s need for cost certainty.

4. Force majeure provisions 

Force majeure provisions are intended to excuse one or both parties from performance of their contractual obligations upon the occurrence of specified events beyond their reasonable control. Whether a particular event falls within the scope of a force majeure clause will depend on the precise wording adopted in the contract. 

During the contractual negotiation stage, parties may choose to draft force majeure clauses broadly, by including a wide range of predefined events, or more narrowly, by limiting relief to specific, clearly identified circumstances. Regardless of the approach adopted, careful drafting is essential to provide contractual certainty, minimise the potential for disputes and ensure that risk is allocated between the parties in a clear and commercially appropriate manner. 

Supply chain procurement 

Early engagement with key suppliers and subcontractors can provide greater visibility of market conditions and facilitate informed decision-making on material selection, procurement strategies, lead times and pricing. 

Contractors may wish to capitalise on local resources and ensure that risks associated with price increases are passed down the supply chain. For sub-contractors, alternative risk mitigation may be required, including healthy contingencies in tender submissions, stockpiling of particularly volatile materials and a careful assessment of each project to determine if it sits within their level of risk appetite.

The Birketts view 

It is increasingly apparent that inflationary pressures are no longer a passing concern but have become a long-term market characteristic of the construction landscape. Cost volatility can materialise quickly with significant consequences for project viability, cash flow and supply chain stability. 

There is no single solution to managing these risks. Instead, parties must take a considered and proactive approach that reflects the specific characteristics of each project. For existing contracts, this will often involve a combination of careful contractual analysis and commercial collaboration to preserve project delivery and mitigate insolvency risks. For future projects, greater emphasis should be placed on risk allocation, the inclusion of appropriate fluctuation mechanisms and the selection of suitable indices and pricing structures. 

Ultimately, the drafting of clear, balanced and commercially realistic contractual provisions remains the most effective means of managing inflationary risk. Parties who fail to address these issues at the outset are likely to face increased pricing, greater dispute risk and reduced project certainty.  

Birketts’ construction and engineering team is experienced in advising on drafting and navigating clients through these issues. Early engagement can help avoid unintended consequences and reduce the scope for dispute as market conditions evolve.