The rate hiking cycle is over. Reticence from policymakers to use language that would even vaguely confirm this proposition still prevails, yet the signs are positive that after this month, we really are done. 

When and how fast will interest rates fall?

Assuming interest rates have peaked, we can once again discuss the inevitable pivot. Across the G7 economies, over the last three decades spanning 25 rate hiking cycles, the average period between the peak and subsequently cutting rates was under eight months. 

With the US Federal Reserve (Fed) last raising rates in July, this would mean a rate cut in Q1 2024. But there’s little expectation of this; financial markets are pricing in a mere 15 per cent probability that the Fed Funds Rate will be below the current value following its March 2024 meeting. 

This time things are different. Monetary policy is proving less effective; the long and variable lags are longer and more variable. This means rates are likely to remain ‘higher for longer’; a message that central bankers have been articulating.

This aligns with expectations for when inflation will fall. The latest European Central Bank (ECB) forecasts expect their 2 per cent inflation target to be met in H2 2025. But this doesn’t necessarily prevent an earlier pivot: while ‘higher for longer’ is the latest slogan used by economists and policymakers, the previous one - ‘transitory’ - didn’t last long.   

There’s a trade-off between economic growth and inflation: how close to the inflation target will central bankers feel comfortable that their job is done, versus how much additional unemployment is ‘acceptable’ to get there. For the Fed, this trade-off is enshrined in their dual mandate. Some central banks, notably the National Bank of Poland, are already easing policy in response to ‘weaker demand pressure than previously expected’. Others, such as the Bank of Korea, are anticipated to follow suit later this year.

In the coming months, how central bankers articulate their thoughts in relation to this trade-off is key to predicting when they will start cutting rates again. The second derivative on inflation is also important (i.e. the rate of change of the rate of change); policymakers need to see a sustainable decline in inflation, even if it’s not back to target. 

What about commercial real estate? 

Firstly, reaching the zenith should be (cautiously) celebrated – stable interest rates are a pre-requisite for any recovery in investor confidence; volatility is not the friend of private markets.

More tangibly, a more stable interest rate will help facilitate a floor in real estate pricing. While some segments may already be there, including well located prime properties in sectors supported by structural tailwinds, looking at prevailing risk premiums would suggest that, in aggregate, the ongoing correction in pricing has further to run. 

This adjustment could be more marathon than sprint. Real estate moves slowly: across seven UK rate hiking cycles over 35 years the all-property yield peaked on average around 22 months after the policy rate. Clearly yield expansion is as much a function of economic conditions as the prevailing interest rate, but outside the major recessions the average lag was still approximately 20 months. 

Our forecast for the UK all-property yield, modelled as a function of interest rates, corporate bond spreads, GDP and unemployment, foresees a peak in Q1 2025 at 5.9 per cent, around 50 basis points higher than current values (based on MSCI UK Monthly Property Index). This implies a lag of around 16-18 months, assuming September represents the end of the UK hiking cycle. 

But again, there’s reason to suggest this time is different. Real estate is much more liquid and transparent than previously – improving price discovery – while valuations are much quicker to respond to market sentiment (especially in the UK). This is reflected in the speed at which pricing adjusted to the current cycle, and highlights the pitfalls in using the past to predict the future.

Finally, interest rate stability will provide some relief for leveraged landlords. Debt costs are ultimately benchmarked off the policy rate. But for many investors, the words ‘higher for longer’ will continue to elicit anxiety. There’s a wall of debt that requires refinancing over the next few years; in the US, some estimates say almost US$ 1.5 trillion. ‘Higher for longer’ is incompatible with ‘extend and pretend,’ and distressed sales will continue to hit the market – music to the ears of potential opportunistic buyers. 

Further information

Contact Oliver Salmon or Charlotte Rushton

To get Savills weekly view on the latest global events shaping the real estate sector, receive ‘the week in review’, an email from our capital markets experts every Saturday morning. Sign up here.