The five-year sterling swap, the benchmark for many UK commercial real estate property loans, has risen steadily in the last three weeks, pushing up costs for borrowers.
According to hedging specialist JC Rathbone Associates, the five-year swap was only 0.46 percent on 27 September but had risen to 0.75 percent yesterday (17 October).
The climb is part of a general rise in forward interest rates in the last few weeks. Gilt yields have also been going up in tandem, after falling to record lows in July ahead of the Bank of England 4 August interest rate cut.
The rise will cancel out savings from lower swap costs made by borrowers over the summer which mitigated rises in senior debt margins which lenders introduced immediately after Brexit. Market sources put the senior loan margin rises at between 25 and 50 basis points.
“Markets have started to forsee substantial inflation on the horizon resulting from a currency crisis which would in turn lead to increases in interest rates” JCRA said in its weekly bulletin to clients yesterday.
This morning, the UK Office for National Statistics announced that the UK inflation rate rose to 1 percent in September, up from 0.6 percent in August, and the biggest monthly rise for more than two years, since June 2014. The ONS was careful to say that it didn’t attribute the rise to the devalued pound. The Bank of England has said it will look through currency-imported inflation in its interest rate decisions.
Economists, however, are now predicting that as the fall in the value of the pound makes imported goods more expensive, the Bank of England’s target 2 percent inflation rate will be exceeded in 2017. JCRA said markets are now pricing in an implicit inflation level of 3 percent for the next five years.
Jonathan Lye, a director at JCRA focused on real estate, said the rise in the five-year swap rate “is really quite significant and seems to be driven by three main subjects: currency, inflation and sovereign risk.
“They are all quite closely associated with Brexit. There was a lot of comment at the Conservative Party Conference (2-5 October) around a ‘hard’ Brexit and we had the ‘flash crash’ fall in the currency (6-7 October) afterwards. The currency level has an impact on inflation and a hard Brexit brings up the prospect of tariffs putting up the cost of imports.
“Looking at five-year gilt yields, they have come up in tandem with the swap rate. So is there an implication on the sovereign risk here, hard Brexit meaning we’ll have to borrow more. The chancellor Phillip Hammond has already consigned the previous chancellor’s target for the UK being in surplus to history. So as a higher sovereign risk, the bond price should be higher.”
Lye said the rise in the swap would cost borrowers more money. “It pretty much wipes out that saving that was made in June-July when rates were lower. Then, although lending margins were up, perhaps 30 basis points, rates were down 30bps, so borrowers were net-net in the same place. Whereas now with the rates rising that has almost been backed out entirely.”
However, he said “deals are not that tight” that a 30 basis points rise “would break them”, even if they were not as profitable as before. “We haven’t seen any impact on real estate pricing. But if this trend continues for another few weeks that would change.”