The BoE Turns Hawkish?

Hawkish comments from BoE Governor Carney gave sterling a boost late last week. However, the BoE will use macro-prudential policies to cool the housing market before resorting to interest rate hikes.

The BoE Turns Hawkish

At his annual Mansion House speech, Chancellor Osborne pledged to give the BoE greater powers to regulate mortgage lending in order to remove the froth from the housing market. This would entail setting limits on loan-to-value and loan-to-income ratios to discourage excessive borrowing.

Despite being given new policy levers, BoE Governor Carney also warned that he could raise rates sooner than the markets currently expect (which was April 2015). Not surprisingly, sterling reacted positively to Carney’s comments.

Our FX strategists think it is premature to conclude that a BoE tightening cycle is imminent. While the housing market is hot, the economic recovery in the U.K. is unbalanced and inflationary pressures are muted. For example, the trade deficit is at record levels and industrial production, while up from the lows, remains 12% below the pre-crisis peak. Meanwhile, CPI inflation is back below the BoE’s 2% target and wages ex-bonuses are rising by just 0.9% yoy.

Bottom Line: The BoE will use macro-prudential policies to cool the housing market before resorting to interest rate hikes. Our F/X strategists recommend staying out of the sterling market for now.

CRE: In A Sweet Spot

Commercial real estate (CRE) is in an expansion phase, backed by favorable global economic trends.

One of the main factors that will support CRE markets globally is the return of growth. The major economies are expanding in a synchronized, if uneven, fashion. This renewed growth impetus has already begun to spill over into CRE expected returns. Like regional growth patterns, the recovery is uneven across property markets as the transition in demand from safety to growth plays out. In times of uncertainty, the trophy markets are sought for a safe and liquid income stream, but during good times, the fundamentals of the non-trophy CRE properties improve with the economy.

Another important driver for CRE is that the demand for safe havens is clearly a thing of past, with gold prices having peaked in 2011. Receding risk-aversion means that interest in riskier assets will once again fuel demand for real estate.

CRE In A Sweet Spot

The third and perhaps most important support for CRE is its link to the monetary policy cycle. Currently, easy money supports rental growth similar to how it stimulates economic activity. Eventually, tighter monetary policy will challenge returns through the higher cost of borrowing and tighter risk premia. However, real estate’s underlying link to growth shelters it, to some extent, from the early phases of monetary policy normalization as the onset of the tightening cycle coincides with an acceleration in economic activity. In other words, real estate’s net-operating income growth (NOI) typically tracks the Fed cycle. The Fed will only tighten policy in the face of accelerating growth, which should coincide with rental growth through increased tenant activity. Therefore, as the case for easy money fades, growth will support real estate returns and compensate for rate hikes in the initial phases of the tightening cycle.

Bottom Line: CRE is in a sweet spot with global growth recovering, investors’ risk appetite rising, and monetary policy supporting CRE’s return drivers. In the U.S., our CRE strategists suggest focusing on economically-sensitive non-major markets with high exposure to technology and industrials.