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It should be no surprise that we are now seeing global interest rates on the rise. The US Fed increased rates three times in 2017 and further increases may be on the way. In November in the UK, Bank of England Governor Mark Carney reversed the post-Brexit base rate cut and moved the benchmark base rate back up to 0.5%, representing the first upward move in UK rates in a decade. And in the eurozone, Mario Draghi has eventually conceded that he will taper quantitative easing next year, paving the way for progress in the EU and, hopefully, positive rates. But are these rate increases premature? There is no denying that the US has experienced some convincing growth in the last 12 months and while President Donald Trump’s massive infrastructure spend looks to be pushed further and further into the distance, the US economy is doing unusually well, for now.
For the UK, the story is not so positive and hopefully the recent rate rise will not prove to be an embarrassing mistake. However, while the UK continues to battle with Brexit negotiations and the instability of Prime Minister Theresa May’s government, it may be some time before we see any opportunity for further rate increases unless we witness some solid economic improvement. In contrast, eurozone GDP grew by 0.7% and 0.6% in the second and third quarters respectively last year and it seems likely that the eurozone is now firmly on track for gradual recovery. Despite all of this, all economies have indicated that any further increase in rates should be treated with caution.
It has been made very clear that any future increases will be measured and will be subject to certain economic targets being met. This qualification is not surprising given the 10 years of financial crisis that global economies have experienced. However, any return to normality will be gradual and any premature rate increases could create a material setback. In regard to global infrastructure, we see this continuing to have material growth in 2018. Renewables in particular we believe will attract much more attention from investors, especially with improvements in technology and the development of new geographies. Governments, however, do not appear to be playing as much of a role in the infrastructure growth story.
In the US, Trump promised in his 2016 election triumph to spend $1trn on infrastructure projects to aid economic recovery and growth. However, more than one year on, the reality is rather different. In the UK, circumstances are not entirely different, with a lack of infrastructure activity. We have heard from successive governments for a number of years that the UK needs, and ‘intends’, to spend on infrastructure to boost the economy and create growth. What a good idea! However, very little has been initiated to date. In contrast, in the eurozone, many countries seem to have recognised the favourable opportunities for infrastructure and are continuing with, or renewing, their infrastructure activity. Admittedly, this is from a very low interest rate base, but the principle is the same. By example, the Netherlands has traditionally led the PPP infrastructure market in Europe, and continues to do so, procuring multiple hard infrastructure projects via the PPP model.
It has never been cheaper to fund infrastructure than now and that applies to all developed economies. There is significant appetite to lend to these projects from (some) commercial banks and institutional lenders and there is material demand for infrastructure. As an asset class, infrastructure is fast becoming the investment of choice. With its long-term visible cash flows and relatively strong pipeline in certain sectors, infrastructure ticks many of the relevant boxes that other sectors struggle to meet. Given the global wall of money that is still looking for a home, we do not see this position changing anytime soon. Yields will have to rise materially in order to tempt investors back to more traditional investments but it will still take some time to exhaust the excess of capital that is sitting with funds eager to invest.
The long-dated transparent cash flows produced by infrastructure, combined with a palatable credit offering with which investors are becoming more comfortable, make for a compelling opportunity. The rise in interest rates that is beginning to evolve will not, we suggest, dent the current favourable reputation that this asset class enjoys. For the foreseeable future, we hope that global economies take full advantage of the prevailing favourable circumstances and make infrastructure not only a financially attractive investment, but also make it instrumental in global economic recovery.
This article first appeared in the January edition of Partnerships Bulletin. All views expressed here are the Author’s own and are based on information available at the time of writing
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