Consumer prices in Germany have risen sharply in the first months of 2021. In the fourth quarter of 2020, annual inflation remained at -0.25%. Since then, we have witnessed an increase of approxi-mately 150 basis points to 1.2%. There are two particular reasons for this development. On the one hand, VAT returned to its previous level at the start of the new year. On the other hand, energy prices rose sharply in anticipation of the global economic recovery. By way of example, the North Sea Brent oil price increased by around a third in the first three months of 2021. In addition, there are several indications that inflation expectations could continue to rise, particularly in areas where the increasing relaxation of restrictions could produce bottlenecks in demand, such as holiday trav-el. According to the Bundesbank, the rate of inflation could reach more than 3% by the end of the year. This puts increasing pressure on the European Central Bank to abandon its expansionary monetary policy. In the financial markets, this potential shift has already been priced in. In anticipa-tion of a more restrictive monetary policy, investors have been selling government bonds, causing bond yields to increase. In the case of ten-year Bunds, this resulted in the first increase since the fourth quarter of 2019 and the strongest increase since the third quarter of 2013.

So, what does this mean for yields on office property? In principle, rising government bond yields have a negative impact on the real estate markets since they produce both higher financing costs and rising opportunity cost. In other words, investors are being offered an alternative to office property. But is this option really attractive? Ten-year Bunds are still showing negative yields and this is not only true of German government bonds. The market value of eurozone government bonds with a negative yield currently stands at around €5.57 trillion. This equates to around 63% of all eurozone government bonds in circulation. In contrast, the prime yield on office property cur-rently stands at approximately 2.8%, some 300 basis points higher than the yield on ten-year Bunds.

So, how high is the probability of rising interest rates? The European Central Bank has yet to give any indication that it will raise interest rates in the near future. National economies in the eurozone are currently in a recovery phase. To increase interest rates in this phase would seriously jeopard-ise growth and hence the economic recovery. Another argument against raising interest rates is the high sovereign debt levels of eurozone nations. This would increase the interest burden on indebt-ed nations, placing further strain on the sustainability of their debt positions. Accordingly, at the beginning of March, the European Central Bank once again emphasised that it would maintain its favourable financing conditions during the pandemic and that it is also willing to further expand its asset purchase program. This means that government bonds will not be a serious alternative to office property in the medium term. Rather, the reverse is true. Since the majority of eurozone government bonds are still showing negative yields, more capital is likely to flow into the real estate markets. This could mean further yield compression in the core property segment.