UK base rate increased to 0.75 per cent

UK base rate increased to 0.75 per cent 18 March 2022

UK base rate increased to 0.75 per cent

The Bank of England’s Monetary Policy Committee (MPC) has hiked its policy rate for a third consecutive time to 0.75%. The move is in response to CPI inflation reaching 5.5% in January, which is well above the Bank’s 2.0% target. At its February meeting, the MPC predicted inflation would peak at 7.25% in Q2 2022; yet they now believe it will reach 8.00% in Q2 and possibly drift higher.

The MPC acknowledged the inflationary effects and growth risks arising from the war in Ukraine but believes that it has limited influence on global inflation risks. However, the MPC cited growing domestically generated inflation, as firms respond to higher input costs by raising prices. The latest labour market figures, showing the unemployment rate down to just 3.9%, which is lower than pre-Covid, may have persuaded the MPC that there is little spare capacity in the economy, which is an inflationary risk.

In its press release, the Bank cited the need to anchor the inflation expectations of firms and consumers, which is consistent with recent speeches by MPC members. Thus, the MPC wants to send a clear message that it intends to act decisively before the public and markets start pricing in permanently higher inflation.

There were also signals from the MPC that rates are set to go higher still although perhaps not as high as some economists are predicting. In its statement, the MPC said: “the Committee judges that some further modest tightening in monetary policy may be appropriate in the coming months, but there are risks on both sides of that judgement depending on how medium-term prospects for inflation evolve”. The press release contains a largely downbeat assessment of economic growth prospects, so this could be a signal that the MPC is willing to change course quickly if necessary.

Given the hike was widely anticipated, and rates are already expected to go higher, we do not see this greatly altering the landscape of the property market in the near term. In the residential market, around three quarters of mortgages are fixed, and house prices have maintained a steady momentum throughout the typically quieter winter months and the Omicron wave. However, the squeeze on household incomes is likely to slow house price growth as the year advances, particularly after the rise in National Insurance payments and the lifting of the energy price cap next month.

For commercial property, we believe the arrival of a higher interest rate environment will shift investment strategies, not reduce activity. Our expectation is investors will respond to the increased cost of money by seeking higher yields. That can be done by pursuing assets with good rental growth prospects, which is still found in the industrial market; although the upside potential has been reduced by the high growth recorded already. Another option is the asset management route, particularly change of use opportunities, such as taking retail and office assets to mixed-use.

Note that in February, the MSCI all property net initial yield stood at 4.3%, and at the time of writing the 10-year Gilt yield is 1.6%, so there is still a healthy risk premium for commercial property.

Overall, we view this rate hike as a change that was widely anticipated, which the property market has already begun to factor into business plans. The issue now is whether economic growth can be maintained through the household income squeeze, and the fallout for prices and supply chains caused by the war in Ukraine. The good news is the Bank of England is clearly aware of these risks and is keeping its options open.

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