Intelligent Investment
Economic Watch: High Inflation, Slower Growth to Sharpen Euro Area Investor Focus on High-Quality Assets
Inflation Rises to 8.6% in June
July 13, 2022 6 Minute Read
Executive Summary
- The Harmonised Index of Consumer Prices (HCIP) for the Euro Area increased to 8.6% year-over-year in June 2022, up from 8.1% in May, representing another all-time high.
- Core inflation, which excludes energy, food, alcohol, and tobacco, was more subdued at 3.7%, but well over the ECB’s 2% target.
- CBRE expects that Euro Area HICP inflation will peak in Q3 2022 but remain elevated for the rest of the year. Specifically, CBRE expects Euro Area inflation to decrease to 5.8% by the end of the year, before falling below the 2% target by the end of 2023. This outlook, however, is heavily dependent on the trajectory of energy prices.
- Higher inflation has already led to steep increases in long-term interest rates, although they remain historically low, and the ECB is expected to increase short-term interest rates by at least 75 bps by year end. This, combined with high inflation, is expected to lead to a pronounced slowdown in economic growth during H2 2022.
June CPI
Euro Area inflation reached 8.6% year-over-year in June (up from 8.1% in May). This was primarily driven by price increases in energy food, alcohol, and tobacco. Core inflation remained more moderate at 3.7% but remains significantly higher than the ECB’s 2% target.
Figure 1: Euro Area annual inflation, June 2022
Source : Eurostat, Flash estimate – June 2022
Implications by Sector
Logistics
Rising fuel costs and driver shortages have increased freight rates. While occupiers are increasingly seeking rental rate caps and collars due to inflation, the market remains undersupplied and favorable for landlords. We expect occupier demand for industrial and logistics properties to remain strong, but the weakening economic outlook may begin to weigh on the sector later this year and in 2023.
Multifamily
Food and energy costs have risen by 8.9% and 41.9% respectively, placing a significant strain on household budgets. The ECB’s recent postponing of fiscal rules regarding government debt levels has given Euro Area countries flexibility to cap fuel prices, reduce the VAT on energy and pursue direct payments to individuals. These policies, adopted by nearly all Euro Area countries, should support multifamily fundamentals by bolstering the ability of tenants to make rent payments.
Office
New office space may be slow to come to the market as surging material and labour costs as well as construction delays have created headwinds for developers. Consequently, there may be some rental upside for landlords of well-situated office properties due to new supply constraints and heightened demand for high-quality buildings. Occupiers remain challenged by rising operational expenses, higher wages and labour shortages. Nevertheless, we expect leasing activity to rise by 10% for the year in 2022. Additionally, we expect a divergence in performance between the prime and secondary properties to intensify. Occupiers are increasingly opting for high quality sustainable space, even amid broader price pressures.
Retail
In recent months, there has been a marked recovery in retail sales, which have surpassed pre-pandemic levels in continental Europe. Prime rents fell starting at the onset of the pandemic but have since stabilised. Select markets have seen a partial recovery, and we expect a modest recovery for both high streets and shopping centres over the next five years. However, elevated inflation has reduced European consumers’ spending power and curbed their appetite for discretionary spending. The war in Ukraine has exacerbated this, as consumer confidence plunged since March. Reassuringly, there has been little impact on overall retail sales thus far, due to the healthy level of savings households built up during the pandemic. We expect convenience-focused retail to continue to outperform as consumers focus on essentials as opposed to discretionary items.
Looking Ahead
CBRE expects HCIP to peak in Q3 2022 and remain elevated for the rest of the year. Inflation should start falling back as supply chains gradually normalise and as a rapid slowdown in economic growth takes the heat out of commodity prices. Overall, we expect inflation to end the year at 6.8% in 2022 and 1.9% in 2023.
Developments in the Russia-Ukraine war remain a key uncertainty for the future path of energy and food prices. If Russia were to continue cutting back gas supply, or even take major pipelines offline entirely, Euro Area countries would be faced with stronger economic headwinds.
CBRE expects that despite current headwinds, Euro Area GDP will be up 2.4% in 2022. However, we expect economic growth will slow significantly in H2 2022, with notable downside risk to our forecast. Consumers, supported by government assistance, strong household balance sheets and a rundown of “excess” savings as real incomes fall, will continue their spending but at reduced levels.
Despite the expected economic slowdown, commercial real estate market fundamentals remain generally solid. Tighter lending conditions, and subsequent yield expansion, which has now manifested itself uniformly across several major sectors and markets, should focus investor interest on high-quality, sustainable assets in the most liquid markets.
