The European Central Bank is focussed on its mission to bring inflation to a level of stability and reduce the leverage of the European economy, which means a policy of reducing liquidity over the next two years. This was stated by Peter Praet, former Chief Economist of the European Central Bank, who gave a very clear picture of the current economic situation at the annual EPRA Conference, which brings together the CEOs of Europe's listed property companies, at a high-level event held in London on 6 September.
Peter Praet's vision was quite simple. In the Covid crisis of March 2020, the panic situation of a paralysed economy could only be overcome with a monetary injection never seen before. To illustrate, in a fortnight, the US Reserve provided the economy with more than 1 trillion dollars, which is almost 5% of US GDP.
This emergency assistance, which led the ECB to buy up unlimited amounts of debt from EU countries, increased the central bank's balance sheet to an unknown level and brought a level of liquidity to the economy that caused prices to skyrocket and inflation to rise. The path to "drying up" this level of monetary excess requires maintaining interest rates at higher levels than we expected and will take time.
The message was thus simple: we have to reduce the level of debt we live with, so that we can be prepared for the next shock that requires economic assistance like the one we have experienced, in Peter Praet's very clear message.
So will interest rates continue to rise?, asked the audience. Praet's answer signalled that the margin for continuing to raise interest rates is now narrower, because with the current level of debt we can't strangle the debtors, including the governments of the Union. However, he believes that the pace of the reduction will be slower than many people think, not least because the conflict in Ukraine is putting pressure on many raw materials, especially energy, which is always at risk of price rises.
CEOs agree, it's time to reduce debt!
At a CEO round table attended by Ismael Clemente, CEO of Merlin Properties, Simon Carter, CEO of British Land, one of the largest listed companies in Europe, and Margaret Sweeney, CEO of the Irish Residential REIT, the consensus was along the same lines.
Investors want companies with stronger balance sheets, with lower levels of leverage, which means favouring companies with lower risk and greater resilience to turbulent times.
This means that companies are now refinancing their debt under more adverse conditions, which will have an impact on their ability to generate funds to remunerate shareholders. The time is therefore ripe to consolidate asset portfolios, with a strong focus and pressure on improving operational efficiency and maximising the operational return on properties under management, including to offset the increased debt costs.
The consensus was clear: the time has come to look inwards, which will mean fewer resources for property development in the portfolios or new acquisitions.
Operating performance is robust in Europe, with Ismael Clemente particularly highlighting the reality in Spain and Portugal. Unemployment is at historic lows, household consumption has proved very resilient, even in the face of the current level of inflation, and all market segments are experiencing a very remarkable performance. This is good news, since good rental income supports the debt reduction effort that is being made, at least in the Iberian reality, as Ismael Clemente has shown.
Private debt is off the ECB's regulatory radar....
Evidence of recent years has been the ECB's tighter regulation of the European banking system, with much stricter criteria for granting debt, especially and particularly for property financing. Regulation is on a macro and micro prudential scale, with instruments of great intervention capacity, and the banks have enormous regulatory demands.
In the words of Peter Praet, this reality has been accompanied by a new private debt market, promoted by funds of various origins, including hedge funds from the world's major management companies, but also from large family offices and wealth managers. The reality of the debt market for these new players has taken on an unknown dimension over the last ten years, while the banking system has reduced its debt exposure.
The event that led to the collapse of Credit Suisse was precisely about a large debtor, which was not on the default radar because its consolidated debt to the banking system was of no concern. It was the volume of debt granted by other private investors that was unknown to the system that led to the collapse, when it became clear that the organisation was in default. In an institution that had historical and well-known problems, a major event led to public intervention and the forced merger with UBS.
Peter Praet has no hesitation in identifying property financing by private capital as a factor in the ECB's clear distrust of the stability and security of the European financial system. The timing of interest rates at levels like the current ones, and especially for a longer period, means an increased level of concern.
The only certainty.... are times of great uncertainty!
The only certainty that remained from the EPRA Conference is that we are living in a time of maximum uncertainty. A view reinforced by Ian Bremmer, founder of the EuroAsia Group, which reflects and advises governments and companies on geopolitics.
We have never lived in a world of such uncertainty, with a war in Europe that no one anticipated on this scale and whose only certain outcome is that Russia has become a "pariah" state. The problem is that never before in history has a country the size of Russia put itself in this position and on these terms.
Ian Bremmer has developed an excellent narrative, seeking to explore the origins of the geopolitical imbalances we are experiencing today. The organisations that today guarantee world order, such as the UN, the World Bank and many others, do not reflect today's world. They are largely the result of the post-World War II era, when these organisations were founded with the power of the victors.
These organisations have not evolved enough to reflect reality and the new balance of power that exists in today's world! This pressure from a vision of a liberal world and a dimension of large countries that are growing more consistently and asserting themselves in the world order, generates the pressures and imbalances in the light of which current geopolitical phenomena should be read.
India, China, Brazil, the countries of the Middle East and even Russia do not share the liberal alignment of the organisations that make up the world order. In particular, the World Bank and the IMF are organisations that are seen as arms of a liberal vision and conception of the world that does not benefit these countries or even align with their secular tradition.