The UK’s credit rating may have been downgraded to Aa1 by Moody’s, but what does this mean for us all? Experts from Fidelity assess the situation and the potential impact of the downgrade.
As expected, one of the main themes from the discussion is a concern regarding the value of the British Pound:
Trevor Greetham, Asset Allocation Director: “The Coalition set out trying to please the ratings agencies but the inflexible application of front loaded austerity is partly to blame for the lack of growth that led Moody’s to downgrade its UK sovereign debt rating on Friday. Government, consumers and the banking system cannot all attempt to deleverage against a weak global backdrop without damaging the economy. This is a classic case of Keynes’ ‘Paradox of Thrift’.
“Ironically, it was a deferral of government spending cuts that lost America its AAA rating in August 2011 but the US strategy of putting off fiscal tightening until the economy is stronger looks to be paying off. US interest rates remain exceptionally low, economic activity is well above pre-crisis levels and clear signs of revival in the housing market suggest the economy may be escaping its debt trap.
“There is a lesson here. Sometimes the ratings agencies are best ignored. They played a pernicious role in the run up to the financial crisis, assigning AAA ratings to flawed debt instruments linked to overheated housing markets. The damage to bank capital ratios when these investments turned sour is what created the credit crunch. Now, with economies facing sustained consumer deleveraging pressure as a result, the same ratings agencies have advised governments to add to the pain by implementing aggressive austerity plans when their economies need as much support as the markets will let them give.”
Andrew Wells, Global Chief Investment Officer, Fixed Income:“The UK’s downgrade from triple-A is very much priced-in and anticipated by professional investors. This is as a consequence of low or no economic growth and consistently high levels of debt. Challenging debt-to-GDP ratios are likely to see more events like this in 2013 from markets traditionally perceived as ‘high quality’.
“This was signalled by rating agencies last year through the negative outlooks they issued. I don’t think savers need to worry about receiving a pound back on their UK Gilts. The worry is what that pound will buy internationally.”
Tristan Cooper, Sovereign Debt Analyst:“Now that the UK’s triple-A rating has been lost, it probably makes sense for the Chancellor to ease the pace of fiscal consolidation in tandem with complicit expansionary monetary policy that is likely under incoming Bank of England Governor Mark Carney. The aim would be to boost growth a bit before the 2015 election. They won’t be too concerned by a further decline in sterling. It is questionable, however, to what degree weaker sterling will really help the economy. The risks for UK Gilts are still on the downside in my opinion.
“It will be tricky to manage a pre-electoral evolution of policy in an orderly way that does not lead to a further loss of market confidence in: a) the economic policy framework; b) its likelihood of success and an eventual stabilisation of public debt. According to the recent EC economic forecast, the level of UK general government debt will overtake France this year and will increase further in 2014, to 98% of GDP. The UK’s structural budget balance has deteriorated of late and, even with further effort, it is still likely to be around 6% of GDP in 2013; this is the second worst in the EU after Ireland. The UK’s general government deficit is likely to be wider than the US this year, at around 7.5% of GDP according to the commission forecasts. At least the Moody’s rating outlook is now stable though – it could have been worse.”
Paras Anand, Head of Pan-European Equities:“The downgrade of the UK’s triple-A rating comes at an interesting point as the focus both from the UK government and from the Bank of England commentary had clearly started to move away from management of the deficit to supporting the economy. I would see the disappointing 4G auction as an event that brought the UK Government’s budgetary position back into focus.
“The impact on sterling could be modest from here with the market having arguably moved ahead of the announcement. However, the greater impact could be the evaporation of the fledgling optimism that the economy may be about to turn given improving employment numbers, recovery in house prices and the prospect of moderating austerity.”
