Economic Update - Week 35, 2025
Surging long-term borrowing costs: The yield on 30-year UK government bonds has climbed to around 5.6%, the highest since the late 1990s. This escalation intensifies pressure on government finances and could necessitate substantial tax increases or spending cuts.
Persistently elevated inflation and moderating interest rates: Inflation remains stubborn at 3.8% as of July 2025, while the Bank Rate has been lowered to 4% in August. This tight margin leaves limited room for further rate cuts.
Commercial real estate under pressure: High financing costs, speculation around property taxes, high construction costs and affordability constraints are weighing on the sector. Rising macroeconomic uncertainty is dampening investment and outlook for commercial real estate, with investors particularly pulling away from value-add.
Global central banks unwinding quantitative easing and exiting bond-buying programs have reduced demand for long-term government bonds, raising yields worldwide. With global debt levels high and structural demand for long-dated paper declining, term premia have increased. This has led to yields on UK 30-year gilts surging to approximately 5.6%, approaching levels not seen since 1998. These elevated yields reflect growing investor concerns over fiscal sustainability, persistent inflation, and the impact of quantitative tightening.
Inflation stands at 3.8% (as of July 2025), with food price exacerbating the cost-of-living as it reached an 18-month high of 4.2% (August 2025). The August Bank of England interest rate cut from 4.25% to 4%, marked cumulative easing of 1.25 percentage points since August 2024. However, ongoing inflation concerns limit prospects for further cuts. Markets expect at most one more cut this year, but unless something changes dramatically, we don’t anticipate any until 2026.
High gilt yields translate into elevated borrowing costs for businesses and investors – 5-year Sonia Swap Rate now stand at 3.76% a slight increase over the year from 3.70% - and will likely lead to occupiers delaying decisions and investors being more cautious. Developers and commercial property firms face narrower margins or delayed projects as financing becomes more costly. Stubborn inflation translates into high material and construction costs which make value-add projects less attractive.
Chancellor Rachel Reeves faces a £20–40 billion budget shortfall. High borrowing costs have eroded fiscal headroom, potentially requiring additional tax measures. Proposals include property tax reform, VAT on private school fees, windfall taxes, and adjustments to council tax or pension allowances. We expect this will delay investors decisions as they look to understand potentially higher costs of holding real estate.
Speculation around new property taxes—including higher levies on homes over £500,000—has already contributed to a noticeable slump in house prices, reflecting investor caution. Although primarily residential, such sentiment often spills over into commercial property markets, dampening appetite for large-scale investments.
UK Hospitality job losses were around 89,000 since last October, representing almost half of all UK job losses since the last budget a sign of a reduction in disposable income. While some segments (e.g., logistics, data centres, ESG-differentiated assets) may maintain resilience, overall investment especially in retail is likely to slow. Commercial real estate players must weigh financing risks, tax policy uncertainty, and cautious renter behaviour when planning.
Final Thoughts
The UK economy currently grapples with inflation above target, rising borrowing costs, and constrained fiscal flexibility. Global shifts in central bank policy and investor behaviour have pushed gilt yields to historic highs. These dynamics create a challenging environment for commercial real estate, where funding costs are elevated, and policy uncertainty is high. Market participants will need to prioritize capital efficiency, lease quality, and asset resilience as the economic and regulatory backdrop evolves.