The U.K. is “highly likely” to lose its AAA credit rating next year, according to John Wraith, a fixed-income strategist at Bank of America Merrill Lynch.
While the nation currently has top rankings at Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, both Moody’s and Fitch have set their outlooks to negative. Chancellor of the Exchequer George Osborne said Dec. 5 the Office for Budget Responsibility believes he will miss his target to begin cutting debt as a percentage of gross domestic product in 2015-16, a factor that Fitch said weakens support for the rating.
“Logic suggests that the negative outlooks may be resolved with a downgrade,” Wraith said at a press briefing today in London. It would be “no surprise” if that takes place in the first quarter, he said.
U.K. government bonds will underperform U.S. Treasuries and German bunds, he predicted. The extra yield investors demand to hold 10-year gilts instead of similar-maturity Treasuries will widen to around 33 basis points after a rating cut, Bank of America predicts. The spread was 15 basis points at 5:15 p.m. London time.
Credit-rating cuts don’t always signal that bond prices will fall. French 10-year yields have dropped more than 100 basis points, or 1 percentage point, this year despite the country losing its top rating with S&P and Moody’s.
About half the time, government bond yields move in the opposite direction suggested by new ratings, according to data compiled by Bloomberg in June on 314 upgrades, downgrades and outlook changes going back to 1974.