A squeeze on government spending is starting to hit the real economy, with the construction industry feeling the first chill from tightened state budgets.

Kier, one of Britain’s biggest construction and housebuilding companies, gave warning yesterday that the industry was starting to feel the slowdown in public sector spending, as further evidence emerges of a country-wide decline in social housing construction.

Until recently the construction sector has enjoyed an unprecedented boom from increased government spending on schools, hospitals, roads and houses, since Labour came to power. However, deteriorating government finances have put the brakes on that. Public sector construction is worth about £40 billion a year out of the total £110 billion industry.

John Dodds, the chief executive of Kier, said yesterday that the construction slowdown evident in the housing sector may now be beginning to spread into the public sector market for new schools, hospitals and roads.

“We think the economic slowdown is everywhere,” he said. “Construction ultimately cannot avoid, in my opinion, some sort of slowdown. The Government will withdraw money and will not be available as it was.”

Mr Dodds said that local authorities were looking at cutting spending on building maintenance. He said: “On support services local authorities are tight on money – it is not affecting us – but a large part of that [tightening] is for building maintenance. It is by and large everywhere. Budgets this year will be tighter, is my reading of it.”

The spending constraints may also result in cuts to some authorities’ programmes to renovate council housing – the Decent Homes programme – which has provided lucrative work for many mid-sized building contractors. Official figures show that the building of public housing fell by 35 per cent in the first quarter compared with the same period last year, below targets set as part of the flagship government policy.

The Government restated its commitment to affordable housing this week when it unveiled its draft Queen’s Speech of forthcoming legislation. In the public housing sector it has set a target of 45,000 homes by 2010-11 but at present is building only 23,000 homes a year.

Public housing has been hit by the slowdown in the private homes market as housebuilders have traditionally had to provide about 30 per cent of their sites for social housing. There are also concerns about the slow progress of the £45 billion Building Schools for the Future programme, where only a handful of local authorities have managed to award contracts to build secondary schools and construction companies have complained about the complicated procurement process and high costs of bidding.

There are other barriers to public sector projects. Banks are nervous about funding private finance initiative deals because of the credit crunch. Adrian Ewer, chief executive of John Laing, a significant PFI player, said recently that strong relationships were essential to securing financing as speculative investors were no longer interested in the sector.

Separately, cement demand, a bellwether for construction activity, is slowing in the UK. Lafarge, the building materials giant and owner of the cement firm Blue Circle, said this week that UK sales had dipped by 7.8 per cent on last year’s figures.

The government spending constraints come at a difficult time for industry, which already is bracing itself for a wider economic slowdown.

From 2000-01 to 2005-06, government spending rose in real terms by an average of 4 per cent or more, peaking at slightly more than 5 per cent in 2004-05. From this financial year onwards, spending growth is expected to drop to an average of 2 per cent a year from 2007-08 to 2010-11.

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