Increased interest – UK rates are up again! Why a rates rise is actually a good sign for investors
To pretty much no-one’s surprise the Bank of England has raised the base rate to 5.75%. We might have expected the decision, but the cold hard fact of the 5.75% is indeed a little scary…or is it?
Undoubtedly, as a result of the rise, we’re going to see alarmist headlines about the state of the property market in the UK and echoes of the same dire predictions we’ve been bombarded with since the current cycle of increases began in November 2003.
The question is, though, should alarm bells be ringing for BTL investors as well as headline writers?
Let’s have a look at the evidence away from the hysteria.
In fact, since rates hit a low of 3.5% in July 2003, they have been consistently on the rise (apart from an oddity in August 2005 when we had a 25 basis points cut). Yesterday’s rise brought base rates up to their highest level since February 2001, when they were also at 5.75%.
Interestingly, a look at the Bank of England’s data shows that almost exactly a year prior to this 5.75% level was the highest point in the previous cycle after which rates started to fall consistently, 6% in February 2000.
6% on the way?
So, are we headed for 6% now? And, if so, what does it all mean? Time to get out of property in the UK?
Well, the answer to the first question is: probably not, but no one can be sure. And the second, absolutely not! It’s no more time to get out of UK property than it was in 2000.
First, some basics. Why have rates gone up anyway?
The simple reason is that the rate of inflation in the UK is still in excess of the BoE’s 2% target level. It’s on its way down, but it’s proved persistent.
Inflation, everywhere, is back – it isn’t just the UK.
Economies all over the world – at least those that are growing strongly (and this is the key point) are experiencing a resurgence (albeit fairly mild) of inflation.
Let’s look at some interest directions in some markets – some of them, economies of interest because they have a global effect, and some of them of interest from the point of view of a property investor….and some chosen at random.
Global Interest Rates
Current Rate Last Rate
Australia 6.25% 6%
China 6.57% 6.39%
Hong Kong 6.75% 6.5%
Korea 4.5% 4.25%
New Zealand 8% 7.75%
Taiwan 2.88% 2.75%
US 5.25% 5%
Canada 4.25% 4%
Czech Republic 2.75% 2.5%
Eurozone 4% 3.75%
Hungary 7.75% 8%
Norway 4.5% 4.25%
Sweden 3.5% 3.25%
Switzerland 2.5% 2.25%
UK 5.75% 5.5%
Of course there are exceptions, most noticeably Japan, where rates are at 0.5%. But the trend for most economies of wildly varying significance on the global stage is that inflation is a creeping problem.
And what all these other economies – except Hungary – have in common is rising inflation brought about by rapid economic growth. That is, strong growth to extremely strong growth, at least some of which is not driven by increased productivity only – in other words, varying degrees of economic overheating.
We might well also have included Poland – an odd case because its last rise in rates was unexpected.
Nevertheless, the rise of its rate to 4.5% was a reaction to fears of inflation, mainly driven by wage demand growth. The finance ministry said this week that inflation for June is expected to be 2.7 per cent, the first time it will be above the central bank’s 2.5 per cent target in two years.
So, time to switch investment focus from Poland, where rates are on the rise to, say, Hungary, where they are certainly on the way down?
Time to switch investment strategy?
Time to switch an investment strategy to an economy with systemic economic problems that is cutting rates to boost growth and away from an economy that is firing on all cylinders but needs a touch on the fiscal brakes?
Also look at Hungary’s actual rates – a truly scary 7.75%.
The big consideration about Hungary is that it is an economy that is struggling to rectify its dire fiscal deficit – over 9% of GDP and the largest in Europe. And, to be fair, it is making good progress.
As recently as May the International Monetary Fund said that Hungary had escaped a budget disaster, but needed to reform if it hoped reboost growth and have any chance of adopting the euro in the near future.
Whether the government can achieve the 2009 target of a deficit of 3.2 per cent of GDP is highly arguable.
As the government reduces the problem, so the efforts and political costs of reducing it further are magnified – after the 5% level, deficit cutting will rely on controversial health care reforms, as well as those in education, state bureaucracy and pensions.
By any reckoning , there are tough times ahead for Hungary.
Time to invest in its property market? No. Not in our view.
What about another country facing macro economic uncertainty – Latvia?
Growth has been driven by domestic demand, with rising wages and soaring lending sucking in imports and pushing up inflation and property prices.
Wage growth, at about 20 per cent a year, is well above productivity increases. This is swiftly eroding industry’s competitiveness at a time when imports are already growing much faster than exports.
The overheated figures have dashed the country’s hopes of entering the eurozone early. A hard economic landing ahead? Quite possibly.
Rate rises equal economic growth
So, back to the UK and other moderately overheating economies, like Poland, and the Czech Republic.
Poland’s statistical agency recently recalculated GDP growth for last year at 6.1 per cent. That’s despite an interest rate rise. And some forecasters believe GDP growth of 8% this year is not out of the question.
Rising interest rates in economies like these – those that are essentially starting to grow beyond a band of inflation deemed to be acceptable (and a little bit of inflation is, of course, good), is a signal of economic health as the top of the interest rate cycle approaches.
Of course, for an investor, the bottom of an economic cycle is the best time to invest – just as an economy is about to recover and grow.
But calculating when that will be is a mug’s game – unless, of course, you can do just that, in which case you don’t need to read this or any other discussion about investment.
For most of us we need to assess a market based on two things:
1. Is it attractive long term (and interest rates tell us little about this)..and
2. How attractive is it right now to invest in?
If is attractive long-term then it is attractive right now because timing your investment is beyond the reach of most savvy investors who are not actually gifted with second sight!
But, current circumstances that are less than ideal need a certain amount of planning – lowering gearing and shopping around for the best mortgage deal you can find. Certainly, at the top or near the top of the interest rate cycle, you do not want to fix your mortgage.
The key point is now that we’re seeing a very strong rental market – measured in terms of demand (ie low voids) and increases in rents.
Similarly, we are seeing rental markets in Warsaw now start to strengthen significantly. We are moving from an environment of 60% per year capital growth (but a very tough rental market), to good moderate growth – perhaps 10% to 15% for the next two years – but with a strong and healthy rental market.
In the UK we’ll see slowing growth, but continuing strong rental demand.
The key point is this.
Where you have a strong economy you have the creation of jobs. And this generates additional demand for housing.
Depending on the interest rate cycle, that demand will be translated into EITHER rental demand OR price growth.
We are now seeing rental demand strengthen across CEE – and this will increasingly bring investors into cash positive status sooner and balance off the increase in interest rates.
Therefore, we can actually welcome a rise or two in interest rates – even though they can create a more challenging environment – because we are seeing strong improvements in rental.
Everything is fine – so long as the economies keep growing. And, in fact, a little increase in interest rates (with the strengthening rental marketing it brings) is to be welcomed!
If you are a ten year-plus investor, this means more cash now and the storing up of future price growth potential.
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