The Bank of England has raised interest rates to 5%, their highest level in 15 years, as it battles to control stubbornly high inflation.
During its monthly meeting on 21 June, seven of the nine Monetary Policy Committee members voted to increase the bank rate by 0.5 percentage points, pushing it up from 4.5%. It was the 13th consecutive increase to rates since late 2022.
Economists had, in general, been predicting a rise of 0.25 percentage points, but unchanged UK inflation, now at 8.7%, has prompted the bank to raise interest rates more aggressively, and it has not ruled out further increases as it seeks to reach its 2% inflation target.
In a statement, the bank said: "The MPC will continue to monitor closely indications of persistent inflationary pressures in the economy as a whole, including the tightness of labour market conditions and the behaviour of wage growth and services price inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required."
The Office for National Statistics confirmed on Wednesday that inflation remained unchanged for May. It marked a halt to the rate’s downward trend since peaking at 11.1% in October, with spend on air travel, recreational and cultural goods all blamed.
The figures also showed that core inflation, which disregards the impact of energy and food costs, was at its highest rate since 1992. The news was a blow to the real estate sector which has been hoping for clarity on when rate rises will stop so it can better forecast returns.
An increase to interest rates will push up the cost of borrowing and likely drag on real estate pricing again, slowing expectations of recovery in a market characterised by low transactional activity in the first half of 2023.
Mat Oakley, head of Savills UK and European commercial property research team, told CoStar News that the 50 basis points rise would have been a surprise to many people but that it would not affect the market as much as may be expected.
He said: "Many of us were expecting another 25-point basis points rise in the next MPC meeting, so you might argue that it was priced in. In that sense it doesn't make a huge amount of difference to confidence or pricing or transaction volumes, the fact that it went up 50 rather than 25 basis points today.
"We are still waiting for the moment when the markets become confident that the next announcement is not a rise. In terms of a return of transactional activity, I think that is all we are waiting, whereas, I think if we were waiting for a fall, we'd be well into 2024 and months away. But I don't think speaking to our clients that is the problem. The problem is that massive gap between the two-year SONIA [interest rate benchmark for inter bank lending] suggesting 5.5% and the two-year economist view suggesting it's going to be 2.9%. How do you make a decision with that breath of scenarios? So we need to reduce that gap."
Oakley said another reason the market was not seeing as sharp a pick-up in transaction volumes as might have been predicted at the end of last year was due to the same spread of opinion on the forward movement in pricing. He added survey pricing expectations over the next six months were widely spread across all sectors.
"So we're not looking for a turning point, I don't think in interest rates for confidence and activity return, we just need to get to that point where most of us can say hand on heart we believe the next move in the next UK base rate is not upwards. I don't think we're there yet."
Allsop head of research Seb Verity said the decision by the BoE to raise rates was the "only button" it has available to improve the UK’s economic outlook, without government intervention. He explained how the interest rates hike would be handled by the sector and how it could focus landlord's strategies on underperforming assets.
"Clearly cost of finance for everybody is the major issue regardless of whether you are commercial or residential. I think commercial is a lot more easy and more binary decision for the actors in the sector because it is less personal, less subjective, and far more rational – if a model doesn't stack up, you don't do it.
"That is the case with some of the broader societal changes that are ongoing post-COVID for certainly the office market. I think that just adds fuel to that longer term fire about what on earth is our relationship with office stock, what are we doing, how much do we need, what is the stock we need to take forward over the next 10 or 20 years?
"There should be, and there are moves that we have yet to see the fruits of, of people reviewing portfolios and their long-term functionality in the market and their utility and whether or not people have got the strategies to repurpose in retail and office."
Verity added that the interest rates hike could slow down the build-to-rent market, with the cost of borrowing increasing. He said: "A few investors and companies are confident enough in their own model and their own financing streams to jump and do deals, but I think there are a still a few who are newer or have different financial sources and models that are hanging about a bit and not committing, which is not ideal as they are the future supply of the rental market, and we need more of it."
Analysis by Avison Young earlier this month showed that investment volumes dipped to their lowest levels since the third quarter of 2008 as the global financial crisis hit home. A total of £99.3 million of regional offices transactions were recorded in the first quarter, down from £153 million in the final quarter of last year, a 35% drop-off, and £755 million during Q1 2022.
Head of research and economics at Colliers Walter Boettcher said transaction volumes would likely remain subdued after today's announcement. “The level of interest rates is less of a problem for the commercial property industry than the continued uncertainty over where they will land. The market is likely to remain quiet until there is more certainty over the pivot point for the Bank of England and its policy.”
Boettcher added: "Only 50% of the impact from existing rate rises have been felt so far. The remaining 50% is very likely to do the job of dampening demand, especially through a contraction in household disposable income via substantial increases in mortgage costs. This 50 basis points increase, and any others that may follow, will simply mean that that when the pivot comes, rates will fall that much faster to avoid a substantial undershoot of the 2% target, including the risk of a period of possible deflation."
Others warned that the 50 basis points rise would compile further pain on struggling sectors. Roger Clarke, CEO of IPSX, the regulated stock exchange for commercial real estate, said: "The move to raise interest rates today was a difficult political decision and signals a much more hawkish central bank stance than was adopted following the outbreak of COVID.
"Most adversely affected will be the subsectors where rental expenditure and growth is discretionary and/or linked to GDP. Turnover rents in retail, or rents from anything other than the very best offices now look very exposed. Opportunities must now lie in sectors driven by less discretionary spending, with [private rented sector], senior living and student accommodation looking most attractive.
"But valuations will remain under pressure across the board as long as interest rates continue to rise. As risk free/policy rates rise, the required return from real estate must continue to rise as well, explaining why we are seeing yield expansion (and thus valuation falls) even as rental growth continues to be delivered. Until rates start to fall it is hard to see these valuation trends changing direction."
The Bank of England is proving more aggressive in raising rates at present than central banks in Europe and the US, though the story is broadly similar.
Last week the European Central Bank increased its benchmark rate to 3.5%, representing a 0.25 percentage points hike. The ECB added it was “very likely” to increase rates in July as well, warning inflation had been “too high for too long”.
In the US, however, the Federal Reserve decided to hold rates at 5%–5.25%, after 10 consecutive rises. Earlier expectations were that the Federal Reserve would push rates higher by 25 basis points, but the committee’s statement on Wednesday explained that holding the rate will allow it to “assess additional information” and determine how its past tightening is affecting the economy.
Although painful for those borrowing in the UK, the rise in rates could present opportunities to others, particularly foreign investors or those financed by foreign lenders, where the cost of borrowing is lower. Andrew Coombs, chief executive, Sirius Real Estate, an investor in Germany and UK, said: “We are in a different position to some in that we borrow in Germany and spend in the UK so there is a financing advantage, and we think it may lead to more opportunities if the value of property goes down in the UK.
“I would personally like the Bank to increase rates faster and more because that will provide confidence that it will deal with inflation. I believe a small rate rise leads to more uncertainty," he added.