Markets get Moody about sterling after UK credit downgrade

Credit ratings agency Moody's downgraded the UK's debt from triple-A status over the weekend - the first downgrade we've seen since 1978 - sending shivers through the pound.

by Michael Northcott
Last Updated: 19 Aug 2013

Given that the UK economy contracted 0.3% in the final quarter of last year, there was always a chance that the ratings agencies would have a pop at the UK. Over the weekend, Moody’s moved us down a notch from the much-vaunted triple-A credit rating that George Osborne always harps on about, meaning that the cost of government borrowing is likely to rise even further, and prompting a sharp drop in the value of sterling against other currencies. 

In early-morning market activity on Monday, the pound fell to a 30-month low against the dollar at $1.52 to the pound, and a 16-month low against the euro at €1.14 to the pound. This only adds to beating sterling suffered late last week…

But why, we hear you ask, have we been downgraded? Well, a downgrade has been on the cards since before Christmas, meaning that, theoretically, there has already been plenty of time for a fall to be priced into market behaviour – and it does now look as if the pound has stablised, despite its fall.

But Moody’s thinks that the UK’s economy has been weaker than it ought to be over the past five years and, given that there has been next to no growth here since the financial crisis, it's probably right. GDP remains about 3.5% lower than it was just before the meltdown and Moody’s reckons we’re in for another few years of snail-pace activity anyway.

It also thinks that, as a knock-on effect, the government’s deficit-reduction plans have been a lot more difficult than expected. The original promise from Osborne was that net debt, as a proportion of GDP, would be falling by 2015. He has now had to push this back to 2017 or possibly even to the end of the decade, thanks to sluggish economic movement.

After Moody’s made its statement announcing the downgrade, Osborne said: ‘Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it,’ tough talk, considering it’s partly the austerity that Moody’s is objecting to. 

Meanwhile, the state of bank lending to SMEs is still not looking good – the latest Markit data for January shows that non-financial sector businesses paid back a net sum of £200m in loan payments to banks. Ideally, we'd prefer to see a figure favouring lending rather than repaying...

The business secretary Vince Cable also weighed in, saying that the downgrade is ‘largely symbolic’ and that, ‘in terms of the real economy, there is no reason why the downgrade should have any impact'. Again, that’s odd, considering that the Coalition’s main argument in defence of budget cuts over the past three years has always been that we would face total ruin if we lost the triple-A credit status…

Still, whatever the government says, the pound is tumbling. Of course, there is an upside to this: as the value of the pound plummets, so does the real-terms value of the national debt. It also helps export competitiveness. But it's a very fine line between that and a full-blown run on the pound, which would not be a good thing...

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