Encouraging Q1 Economic Data
The UK economy gained momentum at the start of 2025 according to data published by the ONS. The preliminary real GDP estimate showed a 0.7% q/q increase in Q1. Meanwhile, retail sales growth picked up to its fastest pace in three years. Encouragingly, there was little evidence in the GDP breakdown that global tariff uncertainty deterred businesses from making investment decisions in Q1. Also, April’s increase in retail sales coincided with higher household borrowing. This provides tentative evidence that households are starting to spend more freely now that the impact of previous interest rate rises is subsiding.
Trade Deals Improve Outlook
There have been a number of positive developments in global trade, which is good news for the UK given the openness of its economy. First, the US appears to have softened its stance on trade policy, including a de-escalation in its conflict with China. If sustained, this should cushion the blow to global demand and reduce trade-related uncertainty.
Second, the UK has secured or advanced trade deals with the US, India and EU. While the government’s red lines around rejoining the customs union or the single market limit potential gains, the removal of trade barriers should support UK exports.
Sticky Inflation Keeps Cuts Gradual
The reacceleration in inflation in April was driven by a combination of periodic price resets, the implementation of the Q2 Ofgem energy price cap and certain policy measures. We continue to hold the view that the BoE will lower interest rates at a quarterly pace, taking Bank Rate to 3.75% by end-2025. Although, the recent softening in US trade policy and higher-than-expected inflation increase the risk that one of these cuts is pushed into 2026.
Persistent Headwinds for UK Core Capital
Two months after ‘Liberation Day’ exacerbated financial market volatility and necessitated a rapid reassessment of economic growth forecasts, UK commercial real estate investors continue to grapple with a challenging macroeconomic outlook. In turn, demand from traditional UK institutional investors remains subdued as they are forced to focus on achieving sufficient liquidity to meet fund redemption requests.
Core Eurozone Pricing More Attractive…?
The higher interest rates differential with the Eurozone means pricing in other European gateway cities is beginning to stand out. Europe’s more benign inflation backdrop, coupled with a clearer medium-term rate cutting outlook, has helped widen prime CRE yields’ spreads over German Bunds (the equivalent risk-free rate in the Eurozone). Another recent driver has been the US administration’s economic policies, which may be causing a gradual reorientation of global capital flows away from Treasuries into other international markets seen as safer havens, such as German government debt. As a result, prime London office yields are now screening as relatively expensive.
Seeking Income Growth in the UK
However, a closer look at the leasing market dynamics and prospects for income growth across Europe show clearly that the above analysis is far from the full story.
As covered in our previous briefing, take-up of Central London office space rose 30% y/y in Q1 2025, with similar rises in regional CBDs, and supply levels are falling quickly. This compares with falls in take-up of 6% and 29% in Paris and Berlin respectively over the same period. Moreover, vacancy rates in both of these markets have risen over 200 basis points since Q1 2024. The upshot is a much stronger prime rental growth outlook relative to Europe.
Conclusion
Stronger rental growth prospects in prime UK outweigh downside of more expensive risk-adjusted yields which should sustain investor demand this year despite wider macro uncertainty.
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