Signs of Life in Consumer Activity

Against a backdrop of global uncertainty and high interest rates, consumers have prioritised saving over spending, shown by a pronounced rise in the savings rate over the past couple of years. However, there are now subtle signs that consumers are beginning to open their wallets. This was first picked up in high-frequency data including credit card transactions and restaurant bookings. Now it is showing up in official data releases, such as retail sales and output in consumer-facing services.

In our view, consumer spending will be a key driver of economic growth this year. However, a marked resurgence looks unlikely at this stage given the weakness emerging in the labour market.

Pressure Building in the Labour Market

The gradual cooling in the labour market seen over the past couple of years appears to have gathered pace. Two of the most closely watched indicators – job vacancies and payrolled employees – have fallen sharply in recent months (see chart).

The recent weakening in labour demand adds weight to the view that increased costs from work-force related policies are impacting hiring decisions. Indeed, the biggest drop in payroll numbers has been in retail and hospitality, which have been the industries hit hardest by the increase in employment costs.

Bank of England Staying on Tempo

As expected, the BoE kept interest rates on hold in June, sticking to the tempo of quarterly cuts. Despite concerns that the conflict in the Middle East could nudge energy prices higher, the MPC seemed much more focused on domestic factors. As a result, we think that developments in the labour market and consumer inflation expectations will determine the path for monetary policy.

In line with the BoE’s unchanged guidance of a ‘gradual and careful approach’, we maintain our long-held forecast of a quarterly pace of rate cuts, taking Bank Rate to 3.75% by end-2025.

Cause for Optimism Despite Acute Uncertainty

As we reach the halfway point of 2025, real estate investor caution remains high. While worries over the impact of trade tariffs seem to have subsided somewhat, this was quickly replaced by increased geopolitical risk as hostilities in the Middle East escalated.

While oil and gas prices have fallen back swiftly following a brief spike two weeks ago, we expect tariff risks to return to centre stage quickly as the 90-day negotiation window draws to a close. This should continue to contribute to a more cautious and stock-selective approach from real estate investors, albeit the UK is better-placed than most to withstand any further volatility due to the recently announced trade deals with the US, India and EU.

In real estate markets, capital value growth in the three months to May strengthened marginally, and prime transaction yields have begun to show signs of compressing, most clearly in city offices and prime logistics.

Investors Focused on Central London

With acute pressures on rents in a number of core markets, and improved economic growth in the first quarter, investors are still transacting despite the volatile backdrop. In Central London, preliminary Q2 office investment volume points to a y/y rise in activity in H1 2025. This bodes well for our forecast of a c. 25% annual uptick in Central London investment volume this year.

Signs of Weakness in the Industrial Market

With the supply of stock limited relative to depth of investor demand, transaction yields are under downward pressure as buyers continue to chase reversionary potential. However, while MSCI data for Q1 2025 shows c. 65% of industrial leases are still let at levels below ERV - indicators of leasing demand continue to point to moderating rental growth. Net absorption is weakening (figure 6), while growth in e-commerce sales volume has slowed back in line with the pre-pandemic trend.  At the same time, CBI survey data points to 67% of industrial SMEs surveyed working below capacity, suggesting less need for expansion.

Government Policy to Boost Demand

Nevertheless, the sector is still underpinned by long-term structural trends. Regardless of where US tariff rates settle, global supply chains are likely to remain under pressure, which could increase the urgency of nearshoring and strengthening logistics operations. Ecommerce penetration also has room to increase in a number of retail subsectors, not least the grocery sector where it is still sub-10%. 

Moreover, it could be boosted further over the long-term by higher government capital spending. The pledge to increase defence spending to 5% of GDP by 2035 will increase demand for space, particularly in regions with large defence-related employers with long supply chains. Additionally, the stated ambition to foster a doubling in business investment in the advanced manufacturing sector as part of a new 10-year Industrial Strategy could also drive growth.

While encouraging, real estate investors and occupiers will wait eagerly to see if pledges can be turned into reality.