Overview: Yield Shift Spreads Across Europe: One of the clearest trends in Q2 2008 was that the effect of thecredit crunch on prime yields spread more widely across Europe, in terms of both location and sector. There are now very few cities where commercial property prices have not been affected and, while initially it appeared that the retail sector was in some way insulated from the effect, yield shift is now being seen in all property sectors.

It remains true that the biggest yield shift has been recorded in the UK. Despite the fact that yields appear to have stabilisedin the Central London markets, there has been further outward movement in provincial cities. In Birmingham, for example, the prime office yield has increased by 175 bps in the year since the credit crunch began.

The biggest yield movements in the second quarter were in Spain,Ireland, Sweden and France. Although clearly the credit crunch is the trigger, the weakening of their underlying economies is also a factor. Ireland and Spain in particular are experiencing significant economic slowdowns.

It is the extent of the economic slowdown that will ultimately determine the longer term effect on the property sector. Occupier demand is already slowing and in its wake so is the rate of rental growth. Rental growth in the retail and industrial sectors was negative in Q2 and would have been flat in the office sector if not for the increases in Milan and Rome. However, even where rents are falling, the rate of declineis not rapid, and as the supply pipeline in most cities is constrained the downside for rents is generally limited.

Uncertainty is not just affecting the property sector. Both equity and bond markets experienced significant falls in Q2, with the ‘benchmark’10-year government bond yield in most countries increasing sharply. The German bond yield jumped by more than 70 bps during the quarter, its biggest three month rise since 1999, but coincidentally bringing it back to the same level as at the start of the credit crunch.

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European Capital Markets - Aug 08 PDF