Interest rate cut 4th August 2016

The Bank of England has cut interest rates to 0.25% - the first reduction in seven years - and introduced other measures aimed at stimulating the economy post the EU Referendum vote. It is however the Bank's downgraded expectations for growth and its latest indicators on the impact on the commercial property market that has been prompting most reaction from the industry.

The package comprises: a 25 basis point cut in bank rate to 0.25%; a new Term Funding Scheme to reinforce the pass-through of the cut in Bank Rate; the purchase of up to £10bn of UK corporate bonds; and an expansion of the asset purchase scheme for UK government bonds of £60bn, taking the total stock of these asset purchases to £435bn. The last three elements will be financed by the issuance of central bank reserves.

Announcing the measures today the Bank of England said: "Given the extent of the likely weakness in demand relative to supply, the MPC judges it appropriate to provide additional stimulus to the economy, thereby reducing the amount of spare capacity at the cost of a temporary period of above-target inflation. Not only will such action help to eliminate the degree of spare capacity over time, but because a persistent shortfall in aggregate demand would pull down on inflation in the medium term, it should also ensure that inflation does not fall back below the target beyond the forecast horizon."

Referring to the expansion of the Bank of England’s asset purchase programme for UK government bonds it said: "[The programme] will impart monetary stimulus by lowering the yields on securities that are used to determine the cost of borrowing for households and businesses. It is also likely to trigger portfolio rebalancing into riskier assets by current holders of government bonds, further enhancing the supply of credit to the broader economy."

In its separately published inflation report the Bank of England noted that the EU Referendum vote had already impacted commercial property investment activity. 

"The vote to leave the European Union is likely to affect GDP growth through a number of channels,but there are currently few post-referendum data available to assess the scale of those effects.

"Growth was firmer than expected ahead of the referendum, but the available indicators suggest that domestic demand growth is likely to slow over the near term as greater uncertainty and lower confidence drag on activity. That is already apparent in the housing and commercial property sectors, where indicators point to significant falls in activity. The large depreciation in sterling should, however, support net trade in the near term."

With specific regard to the CRE market the Bank continued: "

CRE activity fell significantly ahead of the referendum, and prospects for the CRE market have since weakened further. That fall in activity appeared, in part, to

reflect a rise in uncertainty, while industry contacts also reported some perceptions of prices being near their peak in certain areas. Since the referendum, share prices of UK real estate investment trusts have fallen sharply, and a number of open-ended funds investing in the CRE market suspended redemptions due to liquidity pressures as investors sought to divest from the sector.

"The latest Royal Institution of Chartered Surveyors (RICS) commercial property market survey reported a significant weakening in occupier demand following the referendum, and a sharp fall in investor enquiries — particularly from foreign investors. These moves are consistent with a further weakening in activity in the sector.Reflecting weak demand and activity, CRE prices are also likely to fall over the near term. The RICS survey balance of price expectations turned negative in July, and around a third of respondents reported that the market was in the early stages of a downturn, with that share rising to over half for the London region."

Industry response

The commercial property industry has been responding immediately to the much expected cut with general consensus that it will not significantly impact the sector in the near term while taking more note of the increased downgrade by the Bank of England today in its latest forecasting for UK growth in 2017 and 2018, combined with expectations that unemployment will rise.

Andy Pyle, UK head of real estate at KPMG, said: “The cut in interest rates to 0.25% by the Bank of England isn’t likely to have a major impact on the real estate market by itself, given the current low levels for base rates, and also that a number of lenders have pushed up margins by a similar amount since the referendum.

“Of more interest is the Bank’s view on the outlook for the economy contained in their Inflation Report – it is clear that there has been a weakening in the UK economy since the referendum result but how and when the economy bounces back is the key question. The Bank expects 2.5% less growth over the next two years, and ultimately a weaker economy will lead to lower occupational demand for property, which will have a knock on impact on values. However, I expect that there will be a reasonable degree of variation in the impact on different properties, depending on their location, tenant mix and the leases in place.

“There have been encouraging signs in the commercial real estate transactions market over the last two to three weeks, with a number of transactions concluded or in progress at values not far below where they were before the referendum, and we have seen some of the open ended property funds reopen for redemptions. Whilst a number of overseas investors are being cautious, others are attracted by the depreciation in sterling enabling them to buy more cheaply, and the reduction in interest rates has already had an impact on the value of the pound.”

Peter Cosmetatos, chief executive at real estate lending industry body CREFC Europe, said: "Today's announcement of an interest rate cut feels like a sideshow that is likely to do more harm to savers than good to investor confidence or the economy. What the UK really needs right now is clear fiscal and investment policy from government to support economic growth."

Dr Walter Boettcher, chief Economist and eirector of tesearch, said: “The Bank of England really has limited dry powder, a marginal interest rate cut will make little difference, except to squeeze bank margins further. A further £70bn of quantitative easing through carefully targeted asset purchases may make a difference, but it looks increasingly as the stimulus baton may have to be handed to the Treasury. Look for fiscal stimulus going forward in form of new long-term investment in infrastructure and other strategic assets.

“The Prime Minister has already suggested that emphasis on the Northern Powerhouse and the North West will be broadened to include all regions of the UK, so look for new investment initiatives across regions that have demonstrated a willingness to work sub-regionally through combined authorities, as for example the Sheffield City Region, North East Combined Authority, Tees Valley, Derby and Derbyshire, Nottingham and Nottinghamshire, the West Midlands and West of England.”

Boettcher said there would be little impact on the commercial property investment market.

"Given limited leverage, pricing uncertainty and record low gilt rates, the interest rate cut will make little difference to domestic investors. For non-sterling denominated investors, the rate cut will weaken sterling further and add further shine to UK assets which are already being targeted by overseas investors."

Focusing on the occupier market he added: "While the marginal rate cut will have little technical impact on the availability and cost of debt to the corporate sector, it may have a psychological effect, although it is hard to say whether the effect is positive of negative. While the idea of a rate cut is meant to buoy confidence by showing that the Bank of England is willing to support the economy with stimulus, it may also undermine confidence by suggesting that the economy may be in a worse state than already portrayed. Until there is hard data the MPC may be shooting in the dark."

Miles Gibson, Head of UK Research, CBRE, said: “Following the referendum result, the Bank of England made reassuring noises to the market and opted to wait another month to see if conditions improved. The MPC felt it had to take action with today’s cut representing the strongest monetary policy intervention we have seen to date. This week’s weak PMI numbers across all sectors were likely the final nails in the coffin for any members who had hoped to keep the rate at 0.5%.

“From a commercial property perspective, this base rate cut will not have any big impact on pricing, which is driven by long term rates, although pricing might be boosted by a confidence effect from this cut. With sterling priced assets still looking attractive to overseas investors, whose cost of capital is not driven by UK debt markets, London and the UK most definitely remain a strong investment opportunity.”

Sukhdeep Dhillon, Senior Economist at BNP Paribas Real Estate, said: “Today’s announcement was widely expected but is not likely to have a watershed impact on commercial real estate in the near term.

“The UK commercial property market has been a focal point for global investors hunting for yield in this ultra-low interest rate environment. The lower the interest rates, the more appealing the income return offered by commercial real estate becomes, causing a greater shift in portfolio allocation towards property.

“With a low interest rate environment that may become zero, commercial real estate will likely continue to be seen as a store of value with a positive yield.”

Andrew Burrell, head of Forecasting at JLL, said: “The Bank’s interest rate cut was widely expected after July’s disappointment. Other measures, including £70bn of new asset purchases, were more of a surprise, but still in line with previous hints by Governor Carney. It will be some time before the economic impact of these measures can be judged, but the announcement will help reassure investors and occupiers at a time of intense uncertainty.”

Adam Challis, Head of residential research at JLL, added: “Today's 25 pt base rate reduction will signal to mortgagors that cheap mortgage rates will be around for even longer.

"This will benefit many would be home-movers and we are encouraged by the Term Funding Scheme that will ensure lenders pass on most of the rate reduction to consumers.

"More important for the housing market is a strong, stable economy and the rate cut will help. Post-referendum, we need greater certainty that will encourage housebuilders, protect jobs, and ultimately provide a range of housing that people can afford."