Despite the Christmas hiatus, the euro sovereign debt crisis will continue to adjust prospects for the UK economy on an almost daily basis. While David Cameron’s veto has left many questioning the marginalisation of the UK in relation to the eurozone, Europe remains our largest trading destination, and will be for the foreseeable future. Therefore the UK will not be immune to the continuing problems on the Continent affecting our exported goods and services.
Capital Economics, always a bearish forecaster, expects that the fallout from the euro sovereign debt crisis will result in the UK’s annual GDP of 0.7% for 2011 going negative, to -0.5% in 2012, so recession is likely. In Europe, we expect a prolonged period of weak GDP and flat employment growth, presenting challenges in the short term for the occupational market.
Euro break-up
A Financial Times survey of major companies outlined that many are planning for a break-up of the euro. While in itself this does not mean break-up is a certainty, it does suggest that business investment plans will be on hold until the situation stabilises. This translates into highly uncertain times for investors – but decisions still have to be made regarding where to invest.
In previous downturns, property investment has followed the economy downwards. But in the past year, the amount of investment occurring across Europe has been striking. Q3 recorded an increase of €19bn (£15.6bn) in the “big five” countries.
While investment is unlikely to match 2010’s figure of £81bn, it is clear that Europe’s travails are leading to continued emphasis on defensive and quality products across all asset classes, including property, and will continue to do so into 2012, albeit with lower volumes.
The attention focused on property is not surprising, when considered in the context of the gap with European bond yields, and will remain as long as there is uncertainty regarding the state of European government finances. We think the premium offered between European commercial property and bond yields will remain relatively high due to the low interest rate environment the Euro crisis implies – as further emphasised by the recent interest rate adjustments by the European Central Bank.
But it is important to note that all property is not of equal interest everywhere.
In the office markets, the key northern centres of Paris and the German “big six” are on a different trajectory to the cities of southern Europe, as are the Nordic countries. In the UK, or more specifically London, the office market continues to be driven by overseas buyers, and this is unlikely to decline. Despite the PM’s decision, London remains the most transparent market for international investors, and that is a huge draw. But regional offices are suffering.
UK exceptionalism
And while much is often said about UK exceptionalism in regards to Europe, this is not always meant positively, and trends in retail investment do differ. Historically, a much stronger component of investment for the UK than in Europe, retail investment remains in relative decline compared with Germany and France.
German retail has buyers across all segments, and shows the strongest investment growth in Europe; while in France retail is receiving increased interest. For investors in both, retail presents a more secure income source, underpinned by lower personal debt levels. This is not the case for the UK, where retail investment is falling and heading down to levels last seen at the end of 2008. Purchasers are still buying, but are much more selective in a market characterised by falling household consumption and deleveraging.
The latest retailer administrations, tempered slightly by upbeat reports by some larger retailers, will do little to assuage doubts about the market, especially considering the importance of online sales for those that posted positive Q4 numbers.
The Portas review has highlighted some of the factors affecting the decline of the British high street. Some of her suggestions are impractical, some are not, and I am sure the industry will discuss them widely in the coming year.
Inflation, which has damaged the retail sector so badly, declined to 4.8% for the year to November and looks set to fall even further next year. That will put disposable income into consumers’ pockets, but comes too late to save some retailers from going under in 2012.
Not all centres are in decline and some segments of retail are doing well – luxury being an obvious example – and successful international retailers are filling up gaps in some of the more viable centres. This is the great sorting of wheat from chaff; the end result from an investor perspective may be a much reduced list of towns to buy in.
What the situation within UK retail ultimately reflects is the polarisation between the best and secondary property in Europe. Despite attractive yields offered on cheap assets, and despite the potential offered by active management, investors are unwilling to take additional risk in a very difficult period, despite the pressing need to invest their money.
And with the euro crisis still unrolling, that looks set to be a Europe-wide trend for the immediate future.
