Research

UK Economic Overview

The British economy made a rather uninspiring start to the year. In Q1 2017 the UK economy grew by 0.2%q/q, a similar growth rate was recorded in Q2 of 0.3% q/q, resulting in the UK economy growing at a slower rate than most advanced economies and the EU area as a whole. The Markit / CIPS UK Manufacturing Purchasing Managers’ Index slipped from 56.3 in May to 54.3 in June, the Services PMI also edged down from 53.8 to 53.4 over the same period. With both indices above 50, economic growth is expected to slow but remain positive for the second half of the year.

Meanwhile UK politics moved in a direction that very few predicted. Theresa May’s decision to hold a snap election in order to increase the Conservative’s majority share and proceed with her version of Brexit fell through, resulting in a hung parliament and a fall in Sterling from 1.296 against the dollar to 1.266 a day after the result was called. While the dip in the pound subsequently levelled out, the recent 5-3 vote by the MPC to maintain the Bank Rate at 0.25%, (from 7-1 in the previous month), reflecting the MPC’s near term concerns towards inflation, has caused Sterling to fluctuate in recent weeks. But with one of the more hawkish members of the MPC (Kristen Forbes) having now left the committee and CPI inflation ticking down over the month (from 2.9%y/y in May to 2.6%y/y in June), should mean that the swing in votes returns to a more similar ratio to that seen in May.

Plus, there are various other inflationary measures that seem to suggest that the biggest price increases may be behind us. The growth in input prices (the price of materials and fuels that are used to manufacture goods) continues to slow from its high of 19.9%y/y in Feb-17 to 11.6%y/y in Jun-17. In the past input price inflation has been a good lead indicator of CPI inflation; therefore if the historic correlation between the input prices and CPI continues to hold true, then we could see CPI falling back in line with the Bank of England’s target of 2% by 2018.

Even so, the consumer spending squeeze is expected to continue in the interim. Wages have failed to respond to tighter labour market conditions (the unemployment rate edged down from 4.6% in April to 4.5% for the three months to May), leaving households worse off in real terms. Consequently, consumers have resorted to increased borrowing and reduced savings to supplement incomes, but there is a limit to how much further these trends can continue. The household’s savings rate has now fallen to a record low of 1.7% in Q1 2017, down from 3.3% in Q4 2016, while the Bank of England are now starting to react to the rapid increase in consumer credit by requesting banks and lending companies to toughen their stance on lending criteria.

There are plenty of headwinds to short term growth prospects, the consumer outlook will remain challenging and the smaller contributions to GDP growth from this segment are unlikely to be offset by business investment and trade, but there are also some reasons to feel more hopeful over the medium term outlook. The election has now meant that the UK’s exit path from the EU can be more openly debated, increasing the chance of a more business friendly exit from the EU than that which was envisaged for the UK a few months back.

UK Property Market Prospects

A hung parliament and a slowing economy, did little to change the mood across the property market, as investors continued to pour money into UK real estate. Transactional activity was predominantly driven by overseas investors in Q2, although there were some encouraging signs from other market players, with private investors and listed property companies becoming net investors of property. The buoyancy in investment activity supported asset pricing, resulting in capital growth of 1.1% for All Property over three months to June, (up from 0.9 % for the three months to March). With income returns remaining static at 1.4% over the quarter, this pushed the All Property total return to 2.5% for Q2, equating to a total return of 4.8% for the first half of 2017.

On a sector level, industrials held their lead position, as tight supply conditions and resilient demand resulted in the sector delivering more than double the rate of return achieved across the other main-use sectors. The retail sector has seen a rebalancing in performance, with year to date total returns for central London retail flagging behind all other regional retail markets. As for offices, London continues to benefit from the healthy demand from overseas investors, which together with a steady recovery in the regional office market has resulted in the entire sector delivering far stronger performance for the first half of 2017 than for 2016 as a whole.

We have revised our short term market projections, to reflect the strengthening in market conditions. We are forecasting a c.8% All Property total return for 2017, which is a likely outcome if yields remain at current levels and rental growth softens in line with the general economy. From 2018 onwards capital returns are likely to come under pressure from slower growth prospects and Brexit developments, resulting in income dominant returns for the rest of the five year period. Thus, for the five years as a whole we are predicting a 5.3%p.a. total return from UK property, marginally above our long run required return of  5.1%p.a.