U.K. Stripped of AAA Rating by Moody’s Amid Outlook Weakness
Britain lost its top credit rating by Moody’s Investors Service, which cited weakness in the nation’s growth outlook and challenges to the government’s fiscal consolidation program.
The rating on the U.K. was lowered one level to Aa1 from Aaa and the outlook on the nation’s debt changed to stable from negative, Moody’s said in a statement yesterday. With the U.K.’s high and rising debt burden, deterioration in the government’s balance sheet is unlikely to be reversed before 2016, Moody’s said in the statement.
“We don’t expect much market impact from the downgrade, it was widely expected,” David Tinsley, an economist at BNP Paribas SA in London, said today in an e-mail. “The bottom line is that the U.K. needs to find some growth to raise tax revenues.”
The cut will increase political pressure on Chancellor of the Exchequer George Osborne, with the opposition Labour Party calling on him to scale back his fiscal squeeze as the economic recovery struggles to gain traction. The U.K. economy shrank 0.3 percent in the fourth quarter of last year from the prior three- month period, leaving the country on the brink of an unprecedented triple-dip recession.
The pound fell after the downgrade in the last half-hour of trading in New York, dropping 0.6 percent to $1.5163. Sterling has depreciated 5.6 percent this year, the second-worst performer after the yen among 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes.
The U.S., France and Japan “have not paid up because of downgrades and it is unlikely that the bond market will be where the U.K. feels the most pain,” said Steven Englander, head of G-10 currency strategy at Citigroup Inc. in New York.
Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to data compiled by Bloomberg published in December. Investors ignored 56 percent of Moody’s rating and outlook changes and 50 percent of those by Standard and Poor’s. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974.
“Historically, losing your AAA is actually a bond bullish event.” Charles Diebel, head of market strategy at Lloyds Banking Group Plc in London, said.
Slow U.K. Growth
While the U.K. retains “considerable structural economic strengths,” expected slow growth of the global economy and the reduced speed of debt reduction in the country led to Moody’s decision, the company said in the statement.
“Tonight we have a stark reminder of the debt problems facing our country -- and the clearest possible warning to anyone who thinks we can run away from dealing with those problems,” Osborne said in a statement in London. “Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it.”
Britain’s debt as a percentage of gross domestic product will climb to 98 percent next year from 90 percent last year and 95.4 percent in 2013, the European Commission said in its winter forecast yesterday.
The downgrade “comes as little surprise,” Tinsley at BNP Paribas commented. “The U.K. has a similar gross debt to GDP ratio as France and the U.S., both countries who have lost their AAAs in recent history.” Tinsley expects Fitch to downgrade the U.K. “shortly after the March Budget,” and S&P will probably follow.
Moody’s cut France’s country’s top rating on Nov. 19 by one level. S&P lowered the rating by one step to AA+ from AAA on Jan. 13, 2012. Yields on the nation’s 10-year bonds have climbed 16 basis points, or 0.16 percentage point, since the Moody’s downgrade. The borrowing cost has declined 84 basis points since the S&P cut. Moody’s also downgraded from Aaa Ireland in 2009 and Spain in 2010.
U.S. Treasuries rallied after Standard & Poor’s stripped the U.S. of its top ranking on Aug. 5, 2011, with yields touching a record low 1.379 percent in July 2012. U.S. government debt gained 9.8 percent in 2011, the most in three years, according to Bank of America Merrill Lynch index data.
“This is an era where developed countries are being downgraded on a regular basis,” said Eric Lascelles, chief economist for RBC Asset Management in Toronto.
Osborne’s austerity policies will squeeze the budget deficit to 6 percent next year from 10.2 percent in 2010, when his Conservatives took over in an unprecedented coalition with the Liberal Democrats, according to the predictions by the commission.
“Because of the combination of weak growth outlook, substantial fiscal challenges, high and rising debt burden, and the deterioration in shock absorption capacity, we see that the credit worthiness of the U.K. has deteriorated to a level that is more commensurate with Aa1 rating,” Sarah Carlson, a senior credit officer at Moody’s in London, said in a telephone interview.
Osborne said in his autumn statement Dec. 5 that he’s no longer likely to meet his target to begin cutting the burden of government debt in 2015-16 after his fiscal watchdog cut its growth forecasts. S&P put the U.K.’s rating on a negative outlook a week later.
Fitch Ratings said on the day of the budget that missing the debt target “weakens the credibility of the U.K.’s fiscal framework.” It will conduct a further formal review of the rating in 2013 incorporating the budget, due March 20. Fitch lowered its outlook on the U.K. to negative from stable in March 2012. Moody’s lowered its outlook the previous month.
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