December 2, 2020

Investment Houses comment on Britain’s credit rating downgrade

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aaa-credit-rating_2110910bTom Burroughes Group Editor in London

Editor’s note: Late last week, Moody’s, the rating agency, cut the UK’s rating for debt from Aaa to Aa1, the first time in over three decades that the country hasn’t had a top-level ranking for creditworthiness. The move, while not unexpected – as suggested by the relatively muted market reaction so far – highlights how the UK government has a battle to restore the country’s reputation for solvency.

Angel Gurria Secretary General Of The OECD Announces The Latest Economic Survey Of The UKEyes in the wealth management industry will soon turn to the annual budget statement of the UK government, slated for 20 March. There has still been talk of moves such as a new tax on the wealthy, in the form of a so-called “mansion tax”. Whatever happens next month, it is clear that tax policy is currently being crafted amid very difficult circumstances. In the opinion of this writer, the only long-term solution lies in supply-side measures to boost growth, such as freeing up labour and other markets, and through a simpler and crucially, lower tax burden. That debate, however, can wait for another day. Back to the Moody’s downgrade – here are some comments from the financial industry on what has happened.

Ian Kernohan, Royal London Asset Management

The likely downgrade of UK sovereign debt has been discussed for months, so this was not a surprise and gilt yields have barely moved this morning. The political fallout may be greater, given that the timing of the downgrade comes just ahead of The budget, however neither partner in the coalition has an interest in triggering an early election, so it looks as if the current shape of the austerity plans will remain largely unchanged.

Toby Nangle, head of Multi-Asset, Threadneedle Investments

The United Kingdom is a monetary sovereign, and its government bond yields overwhelmingly reflect the expected path of future Bank of England policy rates. Yields are low because the market believes that rates will remain low, and because of the Bank of England’s policy of quantitative easing. By contrast, eurozone sovereign borrowing costs depend on not only the expected course of ECB policy rates, but also market perceptions of creditworthiness, and so fiscally troubled sovereign yields are correspondingly varied. The government’s frequent comparison between eurozone countries and the UK borrowing costs has served principally to explain to the public the benefits of pursuing a policy of fiscal restraint.

This is not to deny the large structural deficit that the UK has in place, nor that the main aim of the Treasury should be to eradicate this structural deficit. Economists and political parties of all colours agree on this point.

The spectre of a rating downgrade taking the UK on a path towards a Greece-like ‘market hell’ is not relevant. If anything, the UK’s worst case scenario would be to suffer a crisis more analogous to Iceland’s – where ratings downgrades coincided with a precipitous collapse in the currency, the financial system, and domestic and international confidence – but we are a long way from such a scenario playing out.

Azad Zangana, European economist at Schroders

The downgrade therefore comes as no surprise, with the economy double-dipping in 2012, and is currently on the verge of a triple-dip recession. Indeed, both gilts and sterling have been under pressure since the end of 2012, as speculation of a downgrade had been building.

Moody’s did however revise up its rating outlook back to stable, indicating that the UK would not be downgraded further. Overall, this downgrade had been on the cards for some time, and the market reaction this morning suggests there are bigger concerns out there for investors, such as the elections in Italy for example. Both Standard and Poor’s and Fitch also have the UK’s outlook on negative watch, and so we expect the others to follow suit. This could push some investors that are forced to hold ‘AAA’ rated assets to sell out of gilts, however, in a world where the pool of ‘AAA’ rated assets is shrinking, we do not expect to see much of an impact.

The fallout of the downgrade is more likely to be felt in Westminster rather than the City, where Chancellor George Osborne has used the ‘AAA’ rating as a benchmark for economic competence. With less than a month to go before the 2013 Budget, the ‘strategic leaks’ of policy measures have been strangely absent from the news. Osborne’s own party are calling for deeper cuts in spending, with the savings used to cut taxes, while the opposition are calling for more public spending. The ideological debate on the size of government does not help the present situation. The Chancellor should take advantage of near record low borrowing costs to fund long-term infrastructure projects, but at the same time, should focus on structural reforms to boost productivity, which has plummeted in recent years.”

Trevor Greetham, asset allocation director at Fidelity Worldwide Investments

The Coalition [government] 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.

Mark Littlewood, director general at the Institute of Economic Affairs, a think tank

The damaging impact of ballooning national debt, public spending raging out of control and tax rises should not be underestimated. Taking immediate action to tackle the deficit must now be the priority. George Osborne should focus on making sufficient savings in public spending to implement a substantial programme of tax reductions. With the size and scope of the state in Britain at current levels it is no wonder our economy is so fragile. The stranglehold of regulation is hurting business prospects on almost every front. In the lead up to the budget Osborne would be wise to respond by taking urgent action.

Ian Winship, head of sterling bonds, BlackRock

“The timing of this decision is surprising for several reasons. In terms of the economic story we would seem to be past the worst and believe it very unlikely that a factor such as the collapse in construction activity that weighed on GDP in 2012 will reoccur. Risk sentiment is currently strong, risk-free rates remain low, bank funding costs have fallen… As a result, credit availability is improving and the price of that credit (mortgage rates) is falling.

The referenced medium-term growth outlook, which was downgraded by the market last year and by the Office of Budget Responsibility in December’s Autumn Statement, has if anything improved since then. In fact, the current set of financial conditions in the UK – yields below 50 basis points out to mid 2016, bank funding costs sharply down, currency weakening – put the economy in the best situation for a recovery that we have seen since the crisis.

The deficit has also benefitted from several one-off factors over the last 12 months (Royal Mail pension assets, Bank of England QE coupons and profits from its SLS scheme, the 4G spectrum auction) which have significantly reduced the near-term need to raise money in the gilt market.

However, we agree that the “the shock-absorption capacity of the government’s balance sheet” has deteriorated. This has been clear since the eurozone crisis in 2011 shifted the fiscal consolidation off-track but this is not “new” news. The government has no way of offsetting an exogenous shock it’s consolidation plan is fully conditional on a slow path to recovery.

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