Why the threat of a Dubai default has hammered the pound

The UK took a particularly bad pounding on the back of the Dubai ‘default’ news, with sterling and the banking sector sliding. Analysts at Credit Suisse reckon that European banks are exposed to about half of Dubai’s overall $80bn borrowings, which is part of the reason.

But a more interesting point is made by FX analysts at BNP Paribas, highlighted by the team at FT Alphaville. “Dubai World became overleveraged and stands for investment into non-productive real estate investments.” In other words, Dubai bought a lot of over-priced trashy trophy assets. And where has it been buying these assets?

Where else but here? As Alphaville puts it: “Unluckily for the UK, the Middle East and the UAE have for a very long time viewed the British real-estate market as a safe-haven investment.” James Lewis of Knight Frank tells Reuters: “We do expect the Dubai government to step up efforts to raise capital via real estate sales, and sales of their UK assets in particular.”

What does that mean? Well the BNP analysts go on: “Last week, we learnt that foreign investors had put about £3.8bn into UK commercial real estate since the start of this year.” They’ve been doing this to hedge against inflation (as rents tend to rise in line with or above inflation). The resulting inflows from abroad have helped to drive up sterling.

But if we’re about to see a fire sale from Dubai World, commercial property prices could take a serious hit. The result? The support for sterling from foreign buyers of UK commercial property will go out of the window. “This type of sterling inflow will now be seriously challenged by the Dubai crisis and is the real reason for sterling weakness.”

It’s also not great news for UK commercial property – you can read more on why we’re still bearish on the sector in my colleague David Stevenson’s recent cover story in MoneyWeek magazine.