The outlook for the UK economy, inflation and interest rates is uncertain amid the conflict in the Middle East.
The closing of the Strait of Hormuz to international shipping and damage to some of the oil and gas infrastructure around the Gulf. Even if the conflict ended today, the damage caused to critical oil and gas infrastructure and the supply side shock suffered to date suggest that oil-market disruption may continue for several months, with some price and risk effects plausibly lasting into next year. Signs of a persistent inflationary reaction to the conflict will put increased pressure on central banks to raise base rates.
Volatility returned to the world’s financial markets in Q1.
In the immediate aftermath of the outbreak of the conflict in the Middle East, the MSCI world index fell -8.9%. Despite the huge uncertainties, financial markets are pricing in the Strait of Hormuz opening soon. The index has recovered 11.4% since the end of Q1 and is now 5.0% higher year-to-date.
Bond markets have taken a very different approach to the conflict. After the opening shots were fired, yields rose by 80bps for short-dated Gilts and 60 bps or more for maturities of ten years and longer. Unlike equity markets, there has been no recovery in pricing. The yield on 10-year Gilts was 5.02% in mid-April after almost nine weeks of fighting and is now nearing the level reached in 2007.
As the crisis develops the UK’s CRE market is slowing.
All Property total returns of 0.4% in March, as recorded by the MSCI Monthly Index, were amongst the weakest of the last two years. Sentiment has weakened but the market is not yet in negative territory. The direct impact of the war on property pricing has been negligible so far but that may not be the case if fighting drags on and the Strait remains closed. In Q1, rolling 3-month UK commercial real estate performance remained static. All Property total returns, as recorded by the MSCI Monthly Index, increased very slightly to 1.43% from 1.42% in Q4.
Capital growth showed no change over the quarter after a rise of just 4bps three months earlier. All Property total returns decreased to 6.5% from 7.1% in the year to December and in the year to date have further decreased to an annualised rate of 5.9%.
Last quarter’s expectations of a benign economic and interest rate outlook supporting stronger commercial property market performance have been dampened.
In the absence of an immediate ceasefire and free access for shipping through the Strait, our base forecast for total returns has been reduced to 6% in 2026 and 7% over the three years to end of 2028, assuming that there is no monetary tightening. With strictly limited capital growth in the forecast, income is the main driver which benefits the higher yielding segments.
