The U.K.’s ability to keep its AAA credit rating after the U.S. was downgraded may depend on the government sticking to its plan to cut the deficit even as the recovery falters, economists said.
Chancellor of the Exchequer George Osborne today hailed the “credibility” of his plan for Britain’s biggest fiscal squeeze since World War II. That contrasts with U.S. arguments on the debt limit, which Standard & Poor’s said showed the “effectiveness, stability, and predictability of American policymaking and political institutions have weakened.”
“The U.K. will hold its AAA because the chancellor has no intention of scaling back his deficit plan,” said Nick Parsons, head of research at National Australia Bank in London. “Any formal change in stance would lead to a downgrade.”
S&P, Moody’s Investors Service and Fitch Ratings have all assigned the U.K. the top grade with stable outlooks, indicating a change soon isn’t likely. It’s a contrast with France, which may be vulnerable to a downgrade after S&P lowered the U.S. to AA+ from AAA on Aug. 5.
France is the most costly AAA country to protect against default. Credit default swaps on France trade at 153.6 basis points, more than double the U.K.’s 77.5. Spain is at 360.3 basis points and Italy at 333.8 basis points.
A basis point equals $1,000 annually on a swap protecting $10 million of debt.
U.K. bonds rose today, pushing the yield on 10-year gilts down 1 basis point to 2.68 percent as of 11:53 a.m. in London. The premium on the debt over German bunds narrowed to 28.3 basis points from 34.1 basis points on Aug. 5.
Andy Chaytor, a rates strategist at Royal Bank of Scotland Group Plc, advises investors to “stay bullish” on U.K. bonds.
“The only way this is wrong is if the commitment to fiscal austerity wavers,” he said in an e-mailed note today. “There are no signs of this at all.”
The government plans to eliminate Britain’s structural budget deficit by 2015. Osborne wrote in the Daily Telegraph newspaper today that the U.S. rating cut and Europe’s debt crisis are a “vindication” of his efforts and show that governments can “earn credibility.”
S&P cut the U.S. rating after criticizing lawmakers for failing to do enough to reduce the deficit and left the grade with a negative outlook. Lawmakers agreed Aug. 2 to raise the nation’s debt ceiling and to make $2.4 trillion in spending cuts over the next 10 years, less than the $4 trillion S&P said was needed. Moody’s and Fitch affirmed their ratings that day.
The U.K. has benefited from political will to cut the deficit and ignore the criticism of voters and opposition politicians. It suffered a credit-rating scare in 2009, when S&P lowered the outlook to “negative.” The outlook was restored to “stable” in October 2010 after the coalition government showed “a high degree of cohesion in putting the U.K.’s public finances onto what we view to be a more sustainable footing,” S&P said.
As the government cuts spending, the Bank of England is setting aside concern about inflation that’s more than double its 2 percent target to aid the economy. It held its benchmark interest rate at a record low of 0.5 percent this month, and Governor Mervyn King will present the bank’s new economic forecasts on Aug. 10.
“The difficult decisions in terms of spending cuts have still to come through, and it remains to be seen if the economic and political circumstances over the next few years are supportive of those cuts,” said Simon Hayes, an economist at Barclays Capital in London. “A question mark over the U.K.’s rating is likely to be there for some years.”
Vince Cable, U.K. business secretary and a member of the Liberal Democrats, the minority coalition party, affirmed his commitment to the budget plans after the U.S. downgrade.
The opposition Labour Party has challenged the plans, saying they’ve sacrificed growth. Ed Balls, who speaks on Treasury matters for Labour, said yesterday that “by trying to go too far and too fast to bring down the deficit, Mr. Osborne choked off last year’s recovery.”
Economic growth slowed to 0.2 percent in the second quarter from 0.5 percent in the previous three months. The National Institute for Economic and Social Research cut its 2011 growth forecast to 1.3 percent from 1.4 percent last week.
“With the euro zone looking messy and the U.S. in a mess it puts the U.K. in a better light,” said Alan Clarke, chief U.K. economist at Scotia Capital in London. “Osborne has a right to be smug but not to be complacent. We’re not growing much and public finances haven’t improved.”
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