In this month’s briefing, we examine why stronger-than-expected UK growth and tentative labour market stabilisation are complicating the inflation and interest-rate outlook, but supporting commercial real estate leasing demand.
In investment markets, higher discount rates remain a key constraint, but rental growth is cushioning values. Moreover, relative to other major European markets, London offices are in a strong cyclical position to continue attracting global institutional demand.
ECONOMY
Growth: outperforming expectations
The UK economy outperformed the US, Eurozone and Japan in H1 2026. Firmer business surveys and improved consumer indicators suggest activity could remain resilient in Q3. Higher energy costs and Autumn Budget uncertainty may slow momentum, but the economy continues to withstand constrained labour supply, geopolitical volatility and high borrowing costs better than expected.
Labour market: finding a floor?
Labour market evidence remains mixed, although signs of stabilisation are becoming clearer. Payroll employment is still contracting, but unemployment was steady and job-to-job moves rebounded in Q2. Regular pay growth also edged up. This is not yet a sustained recovery, but it suggests labour market softening may be approaching a floor.
Inflation: underlying signals diverging
Headline CPI rose as expected in July, largely reflecting the higher household energy cap, while lower fuel and food inflation provided some offset. However, rising input costs and lagged energy effects point to renewed pressure. UK CPI could peak just above 4% around year-end before returning towards the 2% range by the end of 2027.
Bank of England: hike(s) in play
Economic signals have turned more hawkish. Although one month of firmer data does not establish a trend, a rate hike this year is plausible. However, market borrowing rates are already restrictive, the labour market remains fragile, and Autumn Budget uncertainty could delay business decisions.
REAL ESTATE
Economic resilience supporting leasing demand
Improving productivity is providing support to UK commercial real estate demand. Output per payroll employee across office-based sectors has risen steadily since early 2024, while stronger infrastructure investment could help to ease power, water and digital constraints in time. Defence is another important source of occupier growth: expanding order books and rising exports require additional production capacity and robust logistics networks.
Residential: investment rationale intact
Restricted housing delivery and strong urban working-age population growth continues to reinforce the case for urban residential investment. Planning reform should help unlock development, but high debt and construction costs will constrain supply. Meanwhile, London new-let rents rose 6% year-on-year in July (source: Homelet). Durable demand, limited delivery and rental growth therefore support the sector’s long-term income case.
Pricing: income resilience meets higher discount rates
MSCI data continues to show a divide between occupational performance and investment pricing. Rental value growth remains supported by inflation, economic expansion and scarce supply, but higher interest rates are pushing yields out, particularly in logistics and residential. Real capital values are down marginally this year-to-date - far less than in previous downturns - because the 2022–23 repricing and ongoing rental growth are cushioning values. Even so, narrower spreads over government bonds continue to suppress core investor activity.
Offices: London’s relative position is strengthening
Selective opportunities remain in core markets with credible income growth. Central London office vacancy has fallen below that of its principal European competitors, supported by development levels that never fully returned to pre-pandemic norms. Take-up is also comparatively resilient, running in line with its ten-year average versus around 20% below across core Europe. Lower supply and firmer leasing activity are therefore strengthening London’s relative position as investors place a premium on income visibility.
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