The pound fell to its lowest level since July 2010 against the dollar after Moody’s Investors Service cut the U.K.’s AAA credit rating, sapping demand for the nation’s currency.
Sterling dropped to the weakest in almost 16 months against the euro as Moody’s said its decision was based on weakness in the nation’s growth outlook and challenges to the government’s plan to cut the deficit. U.K. government bonds gained after an aide of Democratic Party candidate Pier Luigi Bersani said there’s increasing risk another Italian election will be needed, spurring demand for safer assets.
“Although the timing of the downgrade was a surprise, overall the market has been anticipating a ratings change,” said Ian Stannard, head of European foreign-exchange strategy at Morgan Stanley in London. “In recent weeks we have seen sterling’s safe-haven status erode. After the initial knee-jerk reaction there is the potential for a rebound.”
The pound fell 0.3 percent to $1.5119 as of 5:20 p.m. London time after declining to $1.5073, the lowest level since July 13, 2010. The U.K. currency dropped 0.2 percent to 87.16 pence per euro after depreciating as much as 1.3 percent to 88.15 pence, the weakest since Oct. 28, 2011.
The U.K. currency has weakened 5.8 percent this year, according to Bloomberg Correlation-Weighted Indexes that track 10 developed-nation currencies. Only the yen has fallen more, losing 5.9 percent. The pound has slumped 7 percent in 2013 against the dollar and 6.9 percent against the euro.
Three-month implied volatility on the pound versus the euro climbed as high ad 9.56 percent, the most since May 18. A similar gauge for sterling versus the dollar increased to 9.23 percent, the highest since June 19.
U.K. 10-year gilts reversed an earlier decline as partial results of the Italy’s election suggest former Prime Minister Silvio Berlusconi may have built a blocking minority in the Senate to deny outright victory to Bersani.
The 10-year gilt yield dropped three basis points, or 0.03 percentage point, to 2.08 percent after climbing as much as six basis points. The 1.75 percent bond due in September 2022 rose 0.24, or 2.40 pounds per 1,000-pound face amount, to 97.155.
Chancellor of the Exchequer George Osborne said markets hadn’t been much affected by Moody’s decision.
“We have not seen excessive volatility in the market today,” Osborne told lawmakers in Parliament in London. “The government’s policy is tested day in and day out in the markets and it has not been found wanting today.”
Investors often ignore credit-rating changes as shown by the drop in French 10-year bond yields following a downgrade last year and a rally in Treasuries after the U.S. lost its AAA rating at Standard and Poor’s in 2011.
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.
“With so many other advanced economies having already been downgraded by at least one ratings agency, we do not expect a major market fallout from the decision,” Goldman Sachs Group Inc. economists Kevin Daly and Sebastian Graves wrote in a note published Feb. 23. “The experience of the U.S. also suggests that any impact will be reasonably short-lived.”
U.K. government bonds lost 2.1 percent this year through Feb. 22, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. German debt dropped 1.2 percent and Treasuries declined 0.7 percent.
While the U.K. faces further downgrades, such an outcome would be unlikely to cause investors to sell gilts, according to Pacific Investment Management Co.
“I wouldn’t be at all surprised if we get a second downgrade and if it comes reasonably soon,” Michael Amey, a money manager at Pimco in London, said on Bloomberg Television’s “The Pulse” with Francine Lacqua. “I’d be surprised if there’s a lot of forced selling on a further move.”