Following on from last quarter where we looked at the impacts of investing in a rising rates environment, this quarter we look at inflation, the driver behind higher rates. In conjunction with inflation, we also dedicate an opening section to the conflict in Ukraine, noting the harrowing humanitarian consequences of the invasion as well as discussing the economic impacts on Europe and the UK. Below is a brief summary of the items we discuss:
Central Europe, which heavily depends on Russia for energy supplies, will undoubtedly be hardest hit by the crisis and could encounter supply shortages and power rationing. The UK should not experience physical supply shortages but will suffer from higher wholesale energy prices. The knock-on impacts will cause inflation to be higher for longer, forecast to end the year at 6.6%. Unfortunately, low-income households will be disproportionately affected by the cost-of-living crisis which has already begun.
We believe the UK markets will continue to offer relative value. The FTSE’s heavy weighting of Banking and Mining companies, plays well in a market where interest rates and commodities are rising. The economy is also diversifying with London gaining the reputation of the tech capital of Europe.
Traditionally, real assets are popular in inflationary environments, as equities weigh the risk of tightening cycles cutting off growth and fixed income prices move inversely with rates. International capital has been allocating to the London office market due to its stability and enduring quality, a trend we do not see reversing any time soon. In London and the wider regions, more evidence is presenting itself that Grade A space is in high demand. The market is slowly appreciating occupiers’ requirements for ESG compliant space, the impact of which will cause the yield gap between Grade A and below to only widen. We also discuss ESG in relation to online retail sales and the logistics market. The cost of online returns can cause retailers to adopt practices not compliant with ESG principles. We argue the combination of ESG impacts and rising bond yields will continue to put pressure on logistics pricing.
In the coming years, central bankers will have to chart a delicate balance to reduce inflation without stalling growth. Monetary policy will have little impact on cost-push inflation and only exacerbate the squeeze on disposable income. We hope for a swift resolution to the unprovoked aggression in
Ukraine but until there is a clear cessation of hostilities, it’s difficult to justify a more positive outlook.
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