Two and a half cheers for the global recovery

Anyone who keeps in touch with the news will have noticed the increasingly upbeat economic announcements over the last 6 months or so. We have seen a very sharp turnaround from the near hopelessness of only a year ago when Europe seemed mired in a post-financial-crisis rut. UK and Eurozone economies emerged from recession by mid-2013 and, by the start of this year, sentiment had hit a 3-year high across the EU.

The outlook is improving globally. After a shallow contraction in 2012 and 2013, Oxford Economics’ latest forecast is for  Europe to grow this year, albeit at a modest rate by historical standards (+1%). The expansion builds next year and activity is set to return to pre-crisis norms after 2016. This recovery is less spectacular than previous cycles, but after almost a decade of stagnation, few will complain.

So given all this good news, why are commentators still uneasy? This is largely explained by uncertainty about the future for interest rates. As the smoke from the crisis clears, Central Banks must unwind the extraordinary monetary measures used during the slump. Just the announcement that the Federal Reserve was considering “tapering” its liquidity injections caused consternation in many emerging markets last year. This volatility has continued, with tapering beginning this January and the prospect of Federal Funds hikes moving closer.

But what does all this mean for real estate? The economic recovery is unequivocally a good thing for demand whatever the uncertainties about interest rates. The current gulf between EMEA occupier and investment markets has become a major concern. It is clear that the strength in one cannot be sustained without the support of the other. The forecast recovery in take-up and the resumption of rental growth relies critically on a stronger economic background.

Monetary policy changes could potentially be more disruptive in raising the cost of debt and pushing up bond yields. At present, Fed tapering has had limited direct impact in Europe. The next phase will be more interesting, however conservatively Central Banks adjust interest rates (see chart). The UK is likely to provide an early test of the re-entry process with repo rates expected to rise in early 2015. By contrast, the Eurozone currently appears several years away from tightening and will have longer to consider the impact.

The only way is up

Outlook for short-term interest rates, February 2014

 chart andrew

If the recovery remains robust and interest rate changes are clearly signalled and executed in an orderly way, the adjustment should be relatively painless. But policy transitions are rarely this neat in reality. So while the road ahead looks considerably less hazardous than in the recent past, we should not rule out a few bumps along the way.