Our Thoughts

UK interest rates, will they or won’t they?

Just two weeks ago it was almost certain the Bank of England (BoE) would raise interest rates at the May meeting, with the market implied probability of an interest rate rise climbing above 90% at one point. But instead the monetary policy committee voted 7-2 to leave interest rates unchanged at 0.5%.

So what’s changed?

UK Q1 GDP was weak: the BoE along with others were expecting a preliminary Q1 GDP growth of 0.4% q-o-q. Instead the first estimates for UK GDP show growth of 0.1% in Q1 from 0.4% growth in the previous quarter. The snow was largely blamed for the slowdown, mainly affecting construction and retail output.

Inflation surprised to the downside:  inflation in March was 2.5% y-o-y as the impact of the sudden drop in the value of the pound after the EU referendum began to fade. The BoE had pencilled inflation at 2.8%. As a result there is no urgency for a rate rise.

Underlying situation is unchanged

The BoE’s view of the underlying situation, however, is essentially unchanged. It believes that while demand growth will be modest by historical standards, supply growth will be even weaker — curbing the rate at which the economy can expand without fuelling inflation. Furthermore, while wage growth is now picking up, lessening the squeeze on householders, it is not clear whether consumers will choose to spend more or to rebuild their savings.

The window for rate rises may have closed

It is beginning to look as though the window for 2018 rate rises may have closed. After leaving interest rates unchanged at the May meeting, policy makers are left with just seven meetings before the UK’s official departure date at which they could potentially push rates higher.

We are also five months away from a critical juncture for Brexit negotiations. The EU’s chief negotiator has said negotiations must be complete before the end of October to give the 27 EU countries time to sign off the deal.

By autumn, inflation could be close to target and although the transition agreement has gone fairly smoothly this could change – resulting in potential political volatility later this year, which warrant rates to remain on hold at least until the end of this year.

On the upside, if the labour market strengthens further, a rate rise in August or later in 2018 is a distinct possibility. Markets are currently placing a 50% chance of the August rate rise taking place

Implications for commercial real estate

While incremental hikes do not have much of an impact on commercial real estate, the cumulative impact over time can. The usual expectation is that rising interest rates will push up property yields.