Our October UK Economic & Real Estate Briefing delves into the UK economy’s resilience to rising labour costs, why gilt yields remain high despite recent rate cuts, and risks to the inflation and growth outlook.
We also explore how strengthening leasing fundamentals and steadily falling swap rates are influencing investment and development activity in the London office market, as well as viability and affordability challenges in the private rental sector.
Jobs market past peak recalibration; growth risks linger
The UK labour market appears to have moved beyond the sharpest adjustments to rising labour costs triggered by April’s increase in employer National Insurance Contributions and the National Living Wage. This was followed by several months of declining employment and job postings, but recent data shows the trend is stabilising; July saw the first rise in vacancies in over a year and job losses have slowed. Bank of England (BoE) surveys echo this, showing fewer CFOs plan to cut jobs or wages, with more absorbing higher costs through lower profit margins.
While this bodes well for inflation, it also signals softer demand, supporting our view that Q3 GDP growth will fall short of the BoE’s 0.4% quarter-on-quarter forecast. September’s PMI data revealed resilient business sentiment, though it may be tested by further fiscal tightening in the Autumn Budget. A potential silver lining is that this could permit another BoE rate cut in December.
Why gilt yields remain high despite interest rate cuts
10-year gilt yields remain near 2008 highs, even after three BoE rate cuts this year. This is because yields partly reflect markets pricing in expectations for future interest rate movements. In short, investors need to see a shift toward a lower future rate path – which would require reduced inflationary pressures - before yields fall further. Other factors keeping yields high include reduced gilt demand from pension funds and the BoE’s Quantitative Tightening programme (QT). UK yields are also influenced by global trends and lingering concerns over national debt, especially following the late-2022 mini-Budget.
Economic impact of Quantitative Tightening
The BoE held its base rate at 4.00% in September but slowed its QT programme, cutting planned bond sales for 2025-26 from £100bn to £70bn. This eases the government’s deficit burden from realised losses on bond sales and supports long-term bond prices by reducing supply to the market.
Overall, we expect 10-year gilt yields to stay close to 4.6% in the near term, with the Autumn Budget on 26 November a potential turning point as the Chancellor balances fiscal discipline with economic growth.
Further encouraging signs of improving office sentiment
Despite challenges such as high inflation and bond yields, the UK office investment market—especially in London—is gradually improving. H1 2025 saw investment volumes up 31% y/y, and a stronger deal pipeline could make this Q4 the busiest by total volume since 2021. Office yields remain stable, supported by positive rental growth prospects, and the return of positive real-terms capital growth in London could market another turning point. Debt costs are still a challenge but are becoming less of a drag; relatively stable 5-year swap rates and more competitive lending terms are making leveraged strategies more appealing. Meanwhile, our teams on the ground report developer sentiment is also improving as strong prime rental growth improves viability. New data from Glenigan showing a substantial year-on-year increase in London office construction starts.
Living sector showing maturity amidst short-term uncertainty
The residential sector faces headwinds, with new home completions in England at a decade low and half-year private rental investment activity down on H1 last year. However, investment is expected to recover as policy clarity improves, and the sector is maturing, evidenced by more secondary market trades that aid price discovery and investor confidence.
Underlying demand drivers remain intact
Long-term demographic and affordability trends continue to support medium-term growth in the residential sector. Despite high wage growth, rental affordability remains stretched, but barriers to home ownership also remain high. With robust demand and limited supply, rental values are set for further growth, we think.
