Bank shelves interest rate cuts as oil price surges
It is most ironic that prior to the present war in the Middle East, US President Donald Trump had been calling for interest rate cuts. Before the commencement of hostilities on 28th February, economists were confident the US Federal Reserve and the Bank of England were moving towards lowering their policy rates. However, Trump’s war, having caused energy prices to spike, has persuaded both central banks to leave rates on hold this week and monitor events. The ECB also left rates unchanged, but even before the war there was no expectation it would cut this year.
The decision by the Bank of England rate setters was unanimous, highlighting how serious an inflationary threat we face.
This shying away from rate cuts is badly timed from a UK growth perspective, as there is now ample evidence the economy needs stimulus. The latest figures show GDP flatlined in January. Meanwhile, wages growth has been decelerating, which means households are not in a good position to face higher energy prices. Certainly, utility bills are set to fall next month, thanks to the lowering of the regulated price cap, but petrol prices are rising.
In its press statement today, the Bank of England pointed out the that hiking interest rates will not control the oil price. This is why we should not rush to assume the Base Rate might start to rise soon. However, if the war becomes protracted then the Monetary Policy Committee (MPC) rate setters will start to worry about ‘second round effects’, where higher energy prices prompt workers to demand bigger pay rises, creating a wage-price spiral.
It is far too early to credibly predict that spiral for inflation is going to happen – that is still a worst-case scenario. However, it is a setback for the economy that in a matter of weeks we have gone from the MPC strongly hinting at rate cuts to voting unanimously for no change. Little wonder forecasters are cutting their predictions for GDP growth this year, while nudging up the inflation forecasts.
So, what does this mean for property?
Given interest rates cuts are on the backburner, then real estate yields will stay higher for longer, and vendors need to be realistic on price expectations. Cash is king, and those who have it are back in ‘wait-and-see’ mode, and will need to see bargains to be tempted into the market. To this backdrop, a vendor who is in a position to wait for better times will do just that, so standby for lower sales volumes at least for the next few months.
Thinking of the medium- to long-term though, two potential trades could emerge for UK property.
Firstly, even prior to this war, countries around the world were increasing defence spending, with the definition of ‘defence’ extending into new areas like cyber-security, drones and robotics. Events in the Middle East will further boost the order books of companies in the defence, aeronautics and hi-tech sectors, which are all areas where Britain excels. A growing perception that the USA has become an unreliable partner will increase the likelihood of orders going to UK firms. So, acquiring a building that has a FTSE 350-listed defence or technology group as a tenant on a long lease could become a tempting investment in 2026.
Second, this war could spark a flight of money to safe havens, and UK property has long attracted capital that wants to steer clear of geo-political hotspots. This trade is typically favoured by risk-averse investors with very long-term horizons, so the focus would probably be on prime property in core locations, with tenants on long leases. We would also expect there to be upside for the luxury residential property market.
Overall, the UK property market looks set in the short-term for lower activity levels due to heightened uncertainty. However, it is ill wind that blows no good, and there are ways the UK economy, and ultimately its property market, could profit further down the line.
