ECONOMY
Weaker growth ahead
The UK’s economic outlook has weakened materially due to the ongoing Middle Eastern crisis. While in our initial base case hoped for a short conflict, intensifying tensions have kept energy prices high, with Brent crude approaching $110/bbl at the time of writing. This is denting consumer and business confidence, as recent Gfk and PMI data indicate falling sentiment and demand. Inflation expectations are also rising, posing fresh challenges for the Bank of England (BoE).[1] As such, we expect UK GDP growth to be materially lower this year than the 1.1% previously forecast, as elevated energy costs will have a lasting impact even if the conflict resolves soon.
Labour market - stabilised
UK labour demand continues to weaken, with payroll numbers down 0.7% in February. However, job vacancies have stabilised and redundancies are declining, signalling some recovery in certain segments of the jobs market.
Wage growth is slowing as employees’ bargaining power wanes. Private sector earnings growth, excluding bonuses, almost halved over the course of 2025 to 3.3% in January 2026, close to the level that the BoE considers consistent with 2% inflation. Though services inflation remains high, this trend supports potential rate cuts, leaving the BoE facing conflicting policy pressures.
Inflation - pressure building
The previous disinflationary trend is now highly unlikely to continue. Higher energy costs are already driving up fuel prices. We now expect inflation to average in the mid-3% range in 2026.
The BoE’s response will hinge on the crisis’s duration and severity, but rate cuts seem improbable in the near term. Indeed, attention has swung to the possibility of 2-3 rate hikes to prevent an energy-driven price spike. However, we think the central bank would instinctively prefer to look through the shock, given the inherent weakness in the wider economy. Borrowing costs have already risen, with government bonds and mortgage pricing up sharply.
REAL ESTATE
Narrative reset
With the energy shock hitting growth and inflation, real estate markets face a stagflationary environment. The case for yield compression has weakened, and a 10-year Gilt yield of almost 5% challenges low risk premia. However, this isn’t a repeat of 2022’s repricing - markets have already absorbed far more significant corrections in recent years. Moreover, there are several economic and market fundamentals that point to a more resilient backdrop for real estate markets.
Occupiers are better cushioned
Overall, consumer and occupier finances are more resilient than before past crises. Households and corporations have stronger cash reserves and lower debt despite rising interest rates. While some sectors still face weak growth and high energy costs, leasing markets are likely to remain relatively stable, with fewer tenant defaults supporting income performance even as capital market uncertainty increases.
Rental growth supported by productivity
Rental growth prospects are stronger than headlines suggest. Office and retail rents are now more affordable relative to occupier earning power due to productivity gains since the pandemic, potentially allowing space for growth in prime, future-proofed properties. However, industrial and logistics rents, having grown strongly since 2019, have grown less affordable and likely to see slower gains, with occupiers more sensitive to costs and location efficiency. This is creating a more selective market, with uneven rental growth across sectors.
Transaction activity is now set to be lower this year, but leasing fundamentals and the fact that markets are almost finished adjusting to structurally higher interest rates should support liquidity. The energy transition, supply chain resilience, defence spending, and AI infrastructure are all raising the strategic value of certain assets and locations, intensifying market bifurcation and supporting valuations for prime properties.
[1] UK inflation expectations surge in new worry for Bank of England | Reuters
