UK: Investor concerns over commercial real estate market crushes GBP - MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the pound has continued to weaken in the Asian trading session extending its sharp decline since the Brexit vote resulting in cable falling to an intra-day low just below the 1.2800-level.

Key Quotes

“Pound weakness accelerated sharply yesterday after breaking below support at just above the 1.3100-level where the low from the end of last month was located. Renewed pound weakness was primarily driven by heightened investor concern over financial stability in the UK which was driven by negative developments in the commercial real estate market.

UK commercial property funds holding more than GBP9 billion of investors’ assets have now announced that they have halted redemptions including M&G’s GBP4.4 billion Property Portfolio, which is the UK’s largest commercial property fund. Stress in commercial property was one of the main areas of concern highlighted by the BOE in their latest Financial Stability Report. Governor Carney added to market concerns by warning that some of the financial stability risks related to Brexit “have begun to crystallise”. It prompted the BoE to ease macro-prudential policy by lowering the countercyclical capital buffer rate from 0.5%   to 0% of banks’ UK exposures with immediate effect which it expects to maintain until at least June 2017.                  

The policy step will help to prevent the supply of credit to the real economy from tightening more materially thereby reducing the risk of a sharper and more prolonged economic slowdown in the UK. The BoE attempted to provide reassurance as  well over  the resilience of the UK’s  financial system highlighting that over the past eight years,  major  UK banks  have raised more  than GBP130  billion of  capital and hold  more than GBP600  billion of high-quality liquid assets which is around four-times the level held before the global financial crisis. The BoE highlighted that overall bank funding costs have remained broadly unchanged so far since the Brexit vote.  As a result, the BoE believes that UK banks have the flexibility to continue lending to UK households and businesses even during challenging times.        

When discussing the financial stability risks posed by the commercial real estate market, the BoE highlighted  that it has experienced strong inflows of  capital from overseas over recent years and valuations in some segments of market notably  in London were highlighted as having becoming stretched adding to its vulnerability. A reversal of CRE inflows would make financing the UK’s record current account deficit more challenging increasing downward pressure on the pound.

The BoE noted that since the referendum, share prices of UK real estate investment trusts have fallen sharply highlighting the risk of future adjustments in CRE prices. They warned as well that any adjustment in CRE markets could be amplified by the behaviour of leveraged investors and investors in open-ended commercial property funds. Any such amplification of market adjustments could affect economic activity by reducing the ability of companies that use CRE as collateral to access finance which is widespread for corporate borrowing. According to a Bank of England Review of bank lending to small and medium-sized, 75% of those UK companies that borrow from banks use CRE as collateral.”