Shortly before the Bank of England raised the UK’s base interest rate from 0.25 percent to 0.5 percent in November, I commented that a rise was ‘unlikely to evoke much of a property market response’, because, I reasoned, a rise looked to have been priced in already.
Debt availability is still constrained and leverage is so modest that a banker suggested recently that his bank’s own stress tests indicated that rates would need to rise by between 2 percent and 3 percent before ‘refi risk’ would even get a mention.
I also commented that sterling may rise marginally because, well, that is what currencies generally do. In the event, it did not. Sterling fell by 2.2 percent against the euro and 0.9 percent against the dollar. By mid-November, it was still down. The gilt curve also shifted down. This did not seem like a normal response.
I failed to remember that currency value is linked ultimately to the return expectations of long-term investors. In this case, Bank of England forward guidance – especially in the Inflation Report – was decisive. Phrases such as ‘growth just above its new, lower speed limit’, or ‘foot off the accelerator’, or ‘the marked slowdown in the rate the economy can grow without generating inflationary pressure’, all look to have encouraged an economic reappraisal. Growth expectations fell.
This begs the question of why the base rate was lifted if the outlook is so weak? Most assuredly, the market response suggests that the ‘lower for longer’ mantra will carry the day and that the rate rise is not seen as a definitive start to a tightening cycle. This may await greater political certainty in 2019.
From a commercial property perspective, my sterling-rather-than-base-rate fixation was driven by a benign outlook on leverage and debt costs, and a greater worry about foreign investor perceptions of the UK.
So far this year, foreign investors account for 50 percent of all UK direct property investment by value and 75 percent for central London. In net terms, foreign exposure to UK property is increasing at a record rate – £11 billion (€12.3 billion) so far – and will exceed previous peaks in 2007 (£11.8 billion) and 2015 (£11.5 billion).
UK institutions and property companies are net sellers. Foreign demand has postponed what many expected to be a soft-cyclical landing. The longer the delay, the harder the eventual fall? Post-referendum, sterling fell by around 15 percent. According to data models, sterling is still 15 percent below its long-term international equilibrium value. Foreign investors have responded to a simple arbitrage.
Should base rates rise at an accelerated rate – a view previously promoted by the Bank of England’s governor – and sterling rises as economic perceptions strengthen, what would this mean for the UK commercial property market? If we accept the latest guidance, rates are not likely to rise at an accelerated rate, sterling is likely to move up only slowly and, by that time, the UK institutional net exposure to property, which is also cyclical, will, in all likelihood, begin to increase and replace reduced interest from overseas capital. That’s why this rate rise should not cause undue concern.