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UK Becomes Next Major Economy to have Credit Rating Downgraded, Proving Austerity Isn’t Working

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Following similar downgrades for the USA and France, the UK has become the next major economy to have its credit rating downgraded. The decision by credit ratings agency Moody’s to downgrade UK sovereign debt on the 22nd of February 2013, while not wholly unexpected, has highlighted the fact that the UK may be losing its safe haven status. Reducing the UK’s domestic and foreign currency government bonds from their prized triple-A rating to Aa1 (for the first time since 1978), Moody’s explained that while the outlook for the country was still stable, medium-term growth prospects remained weak and that the agency expected this to continue into the second half of the decade. The downgrade essentially means that Moody’s is not as confident about the overall outlook for the British economy, however, the country’s actual credit worthiness has not come into question and the UK is not likely to default on its debts. In line with this outlook, Euromonitor does not expect real economic growth to return to pre-crisis levels until at least 2018.

The increasingly controversial austerity policy being followed by the government also came under fire from Moody’s, which cited “the UK's high and rising debt burden” as a key challenge to the fiscal consolidation programme as well as the country’s ability to withstand any external shocks over the coming years. The announcement caused the pound to fall to a two and a half year low against the dollar as of 25th February 2013. The relative weakness of the pound paired with the downgrade will have widespread implications for the UK in 2013, not least by underlining the fact that relentless austerity measures are hindering the British economy.

Implications will be felt politically

The biggest implications of the downgrade will undoubtedly be political as it reignites the debate surrounding the efficacy of austerity policies when trying to kick-start economic growth and fend off the threat of a triple-dip recession.

  • The UK’s reputation as a safe haven currency will be jeopardised by the downgrade. Throughout 2011 and 2012 when the eurozone crisis was at its height, the pound was strong thanks to its relative attractiveness over the weak euro. Now that the eurozone has begun to show signs of recovery, deteriorating sentiment in the UK amongst both consumers and investors has hit the pound which has fallen by 6.8% since the first day of trading in 2013 and the end of trading on Feb 22nd 2013;
  • The impact will be felt by consumers as imports become more expensive, as a result of the downgrade negatively affecting the value of the pound. On the flip side, this will also make British exports more competitive but potential foreign investors may be deterred from buying UK government bonds as the yields on ten year bonds are so low at 2.1% and won’t reward them for holding a currency which has lost nearly 7.0% of its value in the last six weeks.

Downgrade may have a positive impact

While the weak currency will make exports more competitive, many hope losing the triple-A rating will be the wake up call needed for the government to start implementing some counter-cyclical, expansionary fiscal policies.

  • The Chancellor responded to the downgrade by commenting that “far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it”. The downgrade has also discredited the Chancellor somewhat, given his pledge in 2012 to preserve the UK’s triple-A credit rating;
  • As such, it seems unlikely the Chancellor's deficit-reduction policy will change in the medium-term but the effects that similar downgrades have had on other countries do offer some hope. When Standard & Poor’s (S&P) downgraded the USA’s triple-A rating in August 2011, the market rallied and US treasury bonds went on to hit new historic lows in July 2012. Similarly in France, when S&P removed their triple-A rating in January 2012, there was little reaction in the markets but eventually yields on ten year bonds fell to a historic low of 2.0% in December 2012.

Moody’s stripping the UK of its triple-A credit rating isn’t a major disaster for the British economy, the real disaster is the persistent austerity stifling economic growth. For 2013, Euromonitor International predicts we will see real GDP growth of just 0.7% in the UK, while public debt as a percentage of GDP will almost certainly exceed 90.0%.

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