The Federal Reserve’s decision to hike US interest rates by 25 basis points marks a significant turning point in the global economic cycle. It has been a long time coming, but the decision was carefully signalled and well executed, and there are good reasons why occupiers and investors in Europe should remain calm about this lift-off.
The most compelling are:
The move was well signalled and initial market reaction has been favourable
Given so long a period of inaction, some market volatility would have been understandable. Instead, the move was largely priced-in with no unpleasant surprises. The dollar strengthened as expected, but a weaker euro is was not unwelcome, as concerns about deflation have not quite disappeared. Another consequence, lower oil and commodity prices, will also benefit consumers in most European markets.
The Fed underpinned its statement with very cautious forward guidance
Central Bank statements over recent years have been at pains to emphasise that rate rises will be slow and deliberate, responding only when the economy is ready with the potential for quick reversal. Janet Yellen reinforced this in her cautious forward guidance on the future path for US rates. Markets expect US rates to rise slowly, at about 0.5 of a percentage point a year over the medium term, leaving levels still well below pre-crisis averages in 5 years’ time.
ECB and Bank of England will not be following soon
The Fed’s move will mark a divergence in Central Bank policy. This difference in part reflects different speeds of economic recovery and also lower core inflation in Europe. The ECB recently extended its liquidity programme, while the Bank of England has back-pedalled on previously-bullish rate talk. The market expectation now is that the UK is at least 12 months away from tightening, with the ECB unlikely to reverse its stance before 2018.
The economic spill-overs will be modest with the European recovery well set
While global credit conditions may tighten slightly on the margins, other direct economic spill-overs from the US are expected to be limited. In Europe, the recovery is increasingly driven by stronger domestic demand and improving labour markets. This “domestic healing” also means Europe is more resilient to external influences than at any time in the past half-decade. Over the next 2 years, the rate of Eurozone GDP growth is forecast to hit a post-crisis high of 1.8%.
The economic revival is boosting occupier demand and rents
More encouraging economic news in Europe is also increasingly reflected in occupier demand across Europe. Office take-up has been steadily rising over recent quarters and continued economic recovery is expected to sustain the momentum into the next year and beyond. As a result, with supply conditions tight in most property markets, these demand pressures are set to be reflected in rising rents too. The Fed’s decision is not expected to disrupt this momentum.
In the current environment, US interest rate increases should be seen as a sign of health, not a cause for concern. Contrast with Japan, for example, seemingly unable to escape its zero rate policy over two decades after its financial crisis. US rates are still far below the norms of past cycles and it will be many years before these levels are reached again. But the first steps in that direction are a sign that things are returning to normal at last.