Real Estate, Utility sectors set to benefit from European rate cuts

The European Central Bank (ECB) and the Bank of England (BoE) are expected to initiate rate cuts in the second half of 2024, a move that Barclays predicts will significantly benefit rate-sensitive sectors such as Real Estate and Utilities.

These sectors, often considered bond proxies, have faced headwinds due to higher rates but stand to gain relief as the anticipated cuts are implemented.

“Long-duration and rate-sensitive sectors such as Utilities, Telecoms, Staples, and Real Estate could see some relief as cuts come through,” Barclays strategists noted in a report.

This is mainly because of the inherent characteristics of these sectors, where lower borrowing costs and improved refinancing conditions can improve profitability and operational stability.

The Real Estate sector, in particular, is poised for notable benefits. With interest as a significant cost of doing business, lower rates could alleviate some of the financial pressures.

Strategists note that refinancing maturing bonds out to the end of 2026 could see interest costs as a percentage of sales jump from approximately 14% to 21.5% if rates remain high. However, the anticipated rate cuts are likely to mitigate this impact, providing some relief to earnings expectations which have already adjusted lower to reflect higher rates.

Utilities, similarly, should also benefit. The sector has been operating with higher leverage and has felt the pinch of elevated borrowing costs. As rates decline, the refinancing of debt becomes more manageable, thereby improving financial health and potentially boosting equity performance.

Barclays said that even banks are likely to perform well, as increased volumes and well-behaved provisions are expected to partially offset any reduction in profitability from lower net interest margins. Likewise, Europe’s small caps could also capitalize given their higher refinancing requirements.

“We reiterate our view that rate cut beneficiaries should outperform, while our rate hike winners basket should lag, so long/short rates views can be expressed within the equity market,” strategists wrote.

A more benign credit environment is favorable for European equities, Barclays added. The looming easing cycle in the region should alleviate equity investors' credit fears, aligning credit and equity performance more closely.