U.K. Downgrade Meaningless With Bondholders Indifferent
U.K. government bonds climbed for a second day after Moody’s Investors Service cut Britain’s top rank, as investors downplayed the significance of the downgrade.
The yield on 10-year gilts fell to a one-month low today, while the additional yield investors demand to hold Britain’s securities instead of German bunds was at 54 basis points, little changed from before the downgrade. Credit-default swaps on U.K. sovereign debt were also little changed, at 49 basis points, according to data compiled by Bloomberg.
The downgrade of the U.K. to Aa1 sparked a round of political sparring after Chancellor of the Exchequer George Osborne repeatedly referred to retaining the top rating as a test for his economic policy. At the same time, bondholders and economists said rating cuts are a poor indicator of fiscal health. U.S. and French yields are lower than they were when rating companies first downgraded the nations in the past two years.
“The impact on gilts will be limited in the same way ratings downgrades had limited impact on the United States and France,” said Shahid Ikram, head of sovereigns at Aviva Investors, which has the equivalent of $414 billion under management. “For us at Aviva, a more important factor to watch for gilts is the Bank of England’s bond-buying policy.”
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. That’s worse than the longer-term average of 47 percent, based on more than 300 changes since 1974. Investors ignored 56 percent of Moody’s rating and outlook changes and 50 percent of those by Standard & Poor’s.
Gilts have tumbled in the past three months amid signs the nation is struggling to reach its deficit-reduction targets. They’ve also declined as an easing of Europe’s sovereign-debt crisis damped demand for a haven, and after the Bank of England paused its asset-purchase plan.
Only Swedish bonds gave a worse return than the 2.3 percent loss for gilts among 26 sovereign markets tracked by Bloomberg and the European Federation of Financial Analysts Societies since the U.K. central bank said it was pausing its bond-buying on Nov. 8.
Osborne said in parliament yesterday that the government will redouble its efforts to reduce the nation’s debt. The opposition Labour Party called on him to switch his emphasis from deficit reduction to growth, following what it called Moody’s “humiliating” decision.
Britain’s 10-year gilt yield fell three basis points to 2.08 percent yesterday, outperforming similar-maturity German bunds, whose yields slipped one basis point to 1.56 percent. The U.K. 10-year rate was lower than its 2.13 percent close on Feb. 13, 2012, when Moody’s switched its outlook on Britain’s debt to “negative.”
The U.K.’s 10-year yield fell a further seven basis points to 2.01 percent as of 10:30 a.m. London time today, the lowest since Jan. 25.
The pound fell to as low as $1.5073 yesterday, the weakest level since July 2010. It traded at $1.5183 today.
“The rating change tells us only what we already knew,” said Rob Wood, an economist at Berenberg Bank in London. Still, “the change could put a little more pressure on sterling, a lot more pressure on Osborne, and may dent near-term growth a little.”
Moody’s blamed the downgrade on the “continuing weakness” of the U.K. economic outlook and the challenge this poses to Osborne’s fiscal plans. While the U.K. retains “considerable structural economic strengths,” Moody’s also said its rising debt burden reduces its “shock-absorption capacity.”
Osborne said two days ago that the downgrade was a “stark reminder” of the “single most important truth about our economy; Britain has a debt problem, built up over many years, and we have got to deal with 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 on Feb. 22.
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. S&P put the U.K.’s rating on a negative outlook a week later.
Britain’s economy shrank 0.3 percent in the fourth quarter, a first estimate showed on Jan. 25. The Office for National Statistics will publish details on Wednesday, including data on consumer spending, government spending and exports.
“The risks to the growth outlook remain skewed to the downside,” Moody’s said. The U.K.’s economic growth will remain “sluggish,” it said.
Fitch Ratings, which lowered its U.K. outlook in March 2012, said on Dec. 5 that missing the debt target weakens the U.K.’s credibility. It will review the rating in 2013 incorporating the budget, due March 20.
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 in an interview 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.”
Tumbling bonds mark a turnaround from the first years of Cameron’s Conservative-Liberal Democrat coalition, which was formed after elections in May 2010. Gilts had the world’s best returns in 2011 as rising borrowing costs across the 17-nation euro area increased the prospect of a breakup of the monetary union.
“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” by Moody’s, Goldman Sachs Group Inc. London-based 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.”