Article

Borrowing: ECB becomes follower of fashion

European Central Bank moves interest rates north after 11-year hiatus

July 21, 2022

After more than a decade of rate hike stasis, the European Central Bank has raised its policy interest rate.

The ECB raised its benchmark rate by 50 basis points to 0%, with rates now expected to turn positive by the end of this year.

With CPI inflation running at between 5.2% and 20% in May across the eurozone and exceeding the bank’s target for the single currency bloc every month since July last year, “it’s a wonder a move didn’t come sooner,” says David Rea, chief economist, EMEA at JLL.

Global peers such as the Bank of England and U.S. Federal Reserve began moving their rates several months earlier, and by many basis points more, than the ECB. In Europe, Central and Eastern European countries began taking action as early as last July: rates in Poland have risen from 0.1% to 6% in nine months, and those in the Czech Republic are up from 0.25% to 7%.

“There are at least four reasons for the ECB’s tardy response,” Rea says.

First, the bank is balancing monetary conditions across a wide range of countries, he says. At the end of the first quarter this year, eurozone countries such as Germany and Spain had still not recovered to their pre-pandemic level of activity. Meanwhile, several economies, including Ireland, were more than 5% larger.

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Second, market-led monetary tightening had already occurred, reducing the perceived need for increased rates. With 10-year government bond yields up by an average of over 200 basis points over the past year, financial conditions had already altered considerably.

Third, much of the inflationary pressure in the eurozone, at least earlier in the year, was external, resulting from higher international energy and commodity prices: a policy shift would have little effect.

“However, the failure to act then saw price pressures become more widespread and be compounded by the euro’s depreciation,” Rea says.

Lastly, there’s understandably been caution about the growth outlook, which has deteriorated incrementally since the start of 2022. The war in Ukraine created huge uncertainty, and aborting and unwinding a tightening cycle, as the ECB did in 2011, was not an option.

So, now that that first step has been taken, what happens next?

“The ECB’s governing council has telegraphed its intention to keep on moving and raise rates again at its next meeting,” says Rea. “It’s also reiterated its commitment to keep the borrowing costs of highly indebted countries in check, stepping in to prevent the yield on their bonds increasing excessively above benchmark German equivalents.”

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The implications for real estate of a move that has been expected for so long are unclear.

“We often look to policy rates to set the tone, but the relationship is weak, at best,” Rea says. “The link with bond yields, particularly inflation-adjusted bond yields, is closer, but still indirect.”

“Real estate asset yields depend upon far more than just the cost of capital. Structural factors, supply-demand balance, lease terms, tenant quality, and ESG, all matter. As does asset quality, where we are seeing a growing diversion of impact across prime and secondary assets.”

How far and how fast interest rate rises now impact real estate is not as straightforward to foresee.

“That may become clearer by early next year as rates settle and this tightening cycle ends,” Rea concludes.