Late on Friday evening, Moody’s downgraded the domestic and foreign currency government bond ratings of the United Kingdom by one notch from AAA (negative outlook) to Aa1 (stable outlook). Moody’s justification for the downgrade is difficult to argue with as the press release highlighted three interrelated drivers for the downgrade:
1. The continuing weakness in the UK’s medium-term growth outlook due to the anticipated slow growth of the global economy and the drag on the UK economy from the ongoing domestic public and private deleveraging process. Moody’s expects sluggish growth to continue until the second half of the decade.
2. The challenges that subdued medium-term growth prospects pose to the government’s fiscal consolidation – a consolidation that will now extend well into the next parliament where Moody’s expects the UK’s gross general government debt level to peak at just over 96% of GDP in 2016 (excluding the effect from transferring the coupon payments from the Asset Purchase Facility – an effect of roughly 3.7% of GDP in total).
3. As a consequence of the UK’s high and rising debt burden, deterioration in the shock-absorbing capacity of the government balance sheet. Moody’s believes that the mounting debt levels in a low-growth environment have impaired the UK’s ability to contain and quickly reverse the impact of adverse economic or financial shocks
Moody’s does not expect further additional material deterioration in the UK’s prospects or additional difficulties in implementing fiscal consolidation. Therefore it has put the Aa1 rating on stable, signalling no changes in the rating over the next 12-18 months. The rating agency does, however, signal downward pressure on the rating should the current government policies be unable to stabilise and ease the UK’s debt burden or in the event of additional material deterioration in economic prospects or reduced commitment to fiscal consolidation.
Downgrade of more political than economic importance
Once again, Moody’s is first mover in altering Britain’s credit rating. Back in February 2012, Moody’s was the first agency to put the UK on negative outlook, with Fitch following in March 2012 and S&P in December 2012. We have for some time anticipated rating actions from the international agencies as the poor recovery in the UK is by no means a new story. So have the markets and for this reason we do not expect any structural market reaction on the back of this downgrade. On the back of Moody’s release on Friday, sterling fell to a two-year low against USD in the final minutes of the US trading session – but this was on the back of a 5.5% weakening in trade-weighted terms in the first two months of 2013. As we have previous highlighted, sterling is in a perfect storm with the combination of a weaker USD, risk of further easing by the BoE and a dismal growth outlook to weigh on GBP. Together with the outlook for inflation to stay elevated over the next two years, there are plenty of reasons for sterling to weaken other than the downgrade.