The knock-on effect of the Eurozone

The Eurozone economy is facing a lost decade. With deflation accelerating so that prices in the single currency bloc were 0.6 per cent lower in January than a year previously, it now looks increasingly likely that even by 2018, Eurozone GDP still won’t have recovered to the level of 2008.

So where does that leave property investors, including those in the UK? Well, the bad news is that deflation is generally associated with sharp falls in the value of real assets, including property. And while that wouldn’t apply in the UK, where deflation is not yet a problem (though inflation has fallen sharply), there would be a knock-on effect.

In the Eurozone, the prospect of falling real estate prices is only part of the headache – the other issue is that this effectively reduces the value of the collateral borrowers have put up against their properties, compounding the systemic effect if and when they default. Meanwhile, in real terms, the value of property debt increases during periods of deflation.

Moreover, it’s not just deflation itself that we should worry about, but the economic conditions that have led to it. One of the reasons prices are falling in the Eurozone is that demand for products and services is so weak – that’s down to the dismal economic conditions in the bloc. Inevitably, those conditions affect the residential and commercial property sectors, which you can expect to perform poorly, even leaving aside the direct effects of deflation.

That brings us to the UK. Recession in the Eurozone is bound to have a knock-on effect on the UK economy, since it’s our biggest trading partner – indeed, the Chancellor is already blaming the problems in Europe for the slowdown seen in UK GDP growth during the fourth quarter of 2014.

A slowing economy is obviously a negative factor for property prices in both the residential and commercial sectors. And those parts of the property market that are dependent on foreign investment – the top-end of the residential market in London, for example – face the prospect of a double whammy.

That said, foreign investors of property in London and the rest of the UK are global – they include Eurozone investors, but buyers from elsewhere may be able to take up at least some of the slack. This would dampen the worst effects of Eurozone recession.

Nevertheless, the prospect of a period of prolonged deflation across the channel is not to be taken lightly. It will be the Eurozone’s property markets that take the biggest hit, but property investors in the UK may well notice an effect, too.

Let’s hope the European Central Bank’s promise of €1.1 trillion of support for the Eurozone economy ensures that deflation in the bloc is short-lived. We’ve seen how quantitative easing in the UK has lifted markets – including the property sector – and we must hope that the ECB can pull off the same trick.

Attributed to Jonathan Samuels, CEO, Dragonfly Property Finance