The Right Time: The Fall In The Base Rate

What it Means for Capital Markets

The first cut is the deepest 

Today, the Bank of England voted to bring down the base rate from 5.25% to 5.00% on a narrow margin of 5-4 committee members. While many expected this to be the case, this was by no means a foregone conclusion – with the minutes from the last meeting seeing plenty of mentions about being ‘finely balanced’.  

With CPI at 2.0% for the second month in a row – albeit slightly above consensus expectations – the big barrier to rate cuts was likely to be around services inflation which had increased to 5.7% in June, well above the MPC forecast of 5.1%. Even before June’s release, services inflation had been quite sticky, with June seeing a 3.3% increase in accommodation services prices, and a 7.5% increase in live music event ticket prices – partly but not definitely wholly attributed to Swiftflation.  The Bank of England, it seems, will have taken the view that this was anomalous. 

There will now be hope that this is the first of a series of cuts that the Bank will embark upon. While a very different case, the Swiss National Bank has already cut twice, while the suggestions are that the ECB, despite keeping the base rate at 3.75% in July are open-minded towards September, with economic growth, as Christine Lagarde put it - “tilted to the downside”. 

The reduction in interest rates is likely to add to the relative about turn in optimism surrounding the UK at present.  

Economic growth surprised on the upside during the most recent May GDP data – to the tune of 0.4%. 

While political ambitions around strong sustained economic growth are just ambitions at the moment, the new Labour government’s fiscal approach and of course its majority mean that the UK’s political stability is now in greater standing than at arguably any point over the last decade – particularly when compared to political ongoings elsewhere.  

About TIME 

Taking these elements into account, for a number of investors, the first-interest rate cut will be the next piece of the jigsaw in creating an upturn in investment into real estate.  

Our TIME score takes into account four elements for understanding timing of investment strategies – cyclical, momentum, risks and growth trajectory – with the purpose of using real estate market data and economic indicators to predict future movements across sectors, particularly useful with regards to upturns and downturns.  

Within these categories, we capture a wide variety of data including that aligned to REIT performance, over/underpricing, relative liquidity and risk premia. This creates the basis for using TIME score as a forward indicator of both total returns and investment volumes.  

According to our TIME score, while we had seen some improvements in our scoring over the first half of 2024, the market had been crucially lacking what we categorise as momentum – a sign of investor confidence – notably visible through a lack of large deals. 

Source: Cushman & Wakefield Research 

Below 5 before 25? 

Considering the context, the UK lending environment has been relatively benign – with the UK clearing banks particularly competitive on pricing – this has thus far limited the amount of distress across the market.  Nevertheless, cuts in interest rates will further reduce the costs of debt – with the 5-Year SONIA running at ~3.8% in the weeks before the base rate cut, compared to ~3.4% even at the beginning of the year. Reductions in the cost of debt will be essential to unlocking the larger end of the market.  

Where there is cause for concern is the relative pricing of real estate. While there will now likely be a fall in 10-year gilts, the spread between risk free rates and property yields is at a 15-year low and will remain low for the time being. All property yields have increased ~170bps since the middle of 2022, compared to a ~380bps rise in 10-year gilts. This puts the gap between all-property and the risk-free rate at somewhere in the region of ~200 bps, compared to an average of ~430 bps between 2010 and 2019.  

While such a large gap was induced historically as a result of the low interest rate environment, it’s worth noting that the gap between 1998 and 2005 was ~380 bps. Long term structural drivers will continue to impact the outlook of the sectors, impacting the closing of that gap to historic levels. Nevertheless, as the risk-free rate comes down, this will obviously impact the relative attractiveness of real estate, but with valuers in the UK marking down pricing faster than in other countries, there will be a question mark as to whether that reflects the real market, as liquidity increases. 

In all, today’s announcement is very positive for the market, with both buyers and sellers alike now likely to take a renewed view on pricing expectations and the short-medium term outlook.